What if IBKR goes bankrupt and My 400k Inside

Besides Interactive Broker, I used a couple of local and bank trading apps so far.

As many complaints people have, Interactive Broker provides the best margin rates besides brokerage that offers. I did research a bit from their annual report and online since I got quite a bit of money still with them.

What happens if Interactive Brokers go bankrupt?

When a broker goes bust, one of three scenarios will occur:

1. Your holdings are liquidated and returned to you

2. The broker is bought out by another broker and your holdings are transferred to the new broker.

3. The broker misused your funds to repay your debts

While scenarios 1 and 2 are supposed to happen since your stock and cash are held separately from the assets of the broker and not be used to pay creditors when the broker goes bust, scenario 3 happened to a brokerage firm, MF Global, that went out of business.

S&P rates BBB+ for long-term and 'A-2' short-term issuer credit ratings on brokerage Interactive Brokers LLC.

Bankruptcy is a possibility for brokerage firms since they provide margin to their customers and rely on good risk management to prevent exposure. For example, a risk event was oil prices going to negative in an unprecedented event that caused US$104m in loss (even with immediate closing of positions and could be worse if they dragged longer):

On April 20, 2020 the energy markets exhibited extraordinary price activity in the New York Mercantile Exchange (“NYMEX”) West Texas Intermediate Crude Oil contract. The price of the May 2020 physically-settled futures contract dropped to an unprecedented negative price of $37.63 dollars.

Several of the Company’s customers held long positions in these CME and ICE Europe futures contracts, and as a result they incurred losses, including losses in excess of the equity in their accounts. The Company fulfilled the required variation margin settlements with the respective clearinghouses on behalf of its customers.

The Company subsequently compensated certain affected customers in connection with their losses resulting from the futures contracts settling at a price below zero. The Company recognized a loss that did not have a material effect on its financial condition.

• Brokerage firms that went out of business

MF Global was a listed brokerage firm that went out of business in 2011 and caused their client funds to be lost unexpectedly because they took the funds to meet their obligations.

Source: WSJ 

MF Global sold protection to buyers long the underlying assets - eurozone sovereign credits - receiving both yield and capital gains from them. MF Global sold insurance and purchased price and credit default risk of what were increasingly shaky assets.

To meet its obligations, MF Global admitted to accessing what should have been separate client funds. This latter action would appear to constitute fraud, though no one has been charged, as yet, with any criminal wrongdoing.

"I simply do not know where the money is, or why the accounts have not been reconciled to date. I do not know which accounts are unreconciled or whether the unreconciled accounts were or were not subject to the segregation rules. Moreover, there were an extraordinary number of transactions during MF Global\'s last few days, and I do not know, for example, whether there were operational errors at MF Global or elsewhere, or whether banks and counterparties have held onto funds that should rightfully have been returned to MF Global."

- Testimony of Jon Corzine before the House Agricultural Committee Dec. 8, 2011

• Is your money safe with Interactive Brokers?

Based on Interactive Broker, client money is segregated in special bank or custody accounts, which are designated for the exclusive benefit of clients of IBKR.

• This protection (the SEC term is "reserve" and the CFTC term is "segregation") is a core principle of securities and commodities brokerage. By properly segregating the client's assets, if no money or stock is borrowed and no futures positions are held by the client, then the client's assets are available to be returned to the client in the event of a default by or bankruptcy of the broker.

Are Interactive Brokers safe? As a practice, IBKR claimed to hold an excess amount of its own money in this reserve and segregated accounts to ensure that there is more than enough cash to protect all clients. On December 31, 2020, the Company had net capital of $5,122, which was $4,448 above the required net capital of $674.

There are a few risks listed by IBKR which include

• Control by Main Shareholder, Mr. Thomas Peterffy with a majority of the combined voting power of our common stock may give rise to conflicts of interests and could discourage a change of control that other stockholders may favor. 
• On the other hand, if the Main Shareholder change with different values (e.g. maximum profit instead of lower cost for customers), it might change the company direction completely.
• Reliance on proprietary technology to work such as margin management and order routing
• Currency risks 
• Cybersecurity risks to their infrastructure

A portion of client funds is typically invested in U.S. Treasury securities. Although permitted by CFTC regulations, given the credit concerns over foreign sovereign debt, IBKR does not currently invest any client money in money market funds.

Nevertheless, US Treasury securities still contained risks since the currency could be devalued like the many thousands in the history of mankind and 29% of their revenue are outside the USA.

The Company is subject to the Uniform Net Capital Rule, which requires the maintenance of minimum net capital. The Company has elected to use the alternative method permitted by the rule, which requires it to maintain minimum net capital, as defined, equal to the greater of $250 thousand or 2% of aggregate debit balances arising from customer transactions, as defined.

The Company is also subject to the CFTC’s minimum financial requirements (Regulation 1.17), which require it to maintain minimum net capital, as defined, equal to the greater of (a) $20 plus 5% of total retail forex obligations in excess of $10, or (b) 8% of the total commodities risk margin requirement for all positions carried in customer and non-customer accounts. The Uniform Net Capital Rule also provides that equity capital may not be withdrawn or cash dividends paid if the resulting net capital would be less than 5% of aggregate debit balances arising from customer transactions.

• How are Interactive Brokers so cheap?

Interactive Broker is a broker designed for experienced and active investors. Interactive Brokers is cheap by saving and making money by

• Having payment for order flow for IBKR-Lite customers in exchange for zero commission fees similar to Robinhood
• Commissions for IBKR-Pro customers, in exchange for a price improvement of $0.50 based on IBKR
• Having minimal customer service representatives available for hand-holding (unlike some newer trading apps having live chat). IBKR has around 2,033 staff
• Earning from the currency exchange 
• Automated and live margin calculation to manage risk
• Some features are available for free on other brokerages you need to pay for at Interactive Brokers such as live price snapshot

In return, you get quite low commissions and margin rates.