Pooling risks
When you open a margin account, your brokerage would usually ask for a written authorization to re-pledge your securities in the margin account. That authorization enables the brokerage to "pool" and re-pledge margin clients' securities as collateral to secure bank borrowings for the brokerage. Depending on the terms of the authorization, a margin client's securities collateral may be re-pledged in this way even if the client has not borrowed from the brokerage.
By law, your authorization can only be valid for 12 months. Your brokerage will generally send you a reminder when your authorization is about to expire. If you do not object in time, your authorization will automatically be rolled over for another 12 months. So, you may reconsider whether you want to renew the authorization when you receive such a reminder.
Pooling Risks
When margin clients' securities collateral is pooled and re-pledged to a bank by the brokerage, there is always a risk that the brokerage will lack the funds necessary for it to redeem the re-pledged securities from the bank. This may happen when a brokerage experiences very tight liquidity and a number of margin clients seek the return of their securities collateral which has been repledged with a bank at the same time. Furthermore, where the brokerage becomes insolvent, the bank may liquidate the securities collateral re-pledged to it by the brokerage in order to discharge the brokerage's indebtedness. In such a case, a margin client may not be able to recover all the securities in his margin account. These risks associated with the pooling and re-pledging of margin clients' securities are commonly known as "pooling risks".
Once you have given authorization allowing your brokerage to re-pledge your securities, it is possible that all the securities in your margin account will be pooled even if you have fully paid for all your share purchases and have not used the margin facility. All margin clients who have agreed to pooling and re-pledging of their securities collateral risk losing their securities, regardless of whether they have utilised any margin facility.
Depending on the terms of the authorization and due to the pooling arrangement, all the securities in your margin account may be re-pledged regardless of whether their value exceeds your margin position. As a result, you might not get back all your securities in the event that your brokerage encounters any cashflow problems.
In contrast, the position of cash clients is much stronger since their securities are required to be segregated in a trust account.
Don't open a margin account or sign the pooling and re-pledging authorization if you have no intention of using such a facility. If you do need a margin account, make sure you fully understand all the risks associated with pooling and re-pledging of your securities. This includes the risk that you may lose your securities even if you are making money in your margin account or if you have not used the margin facility. If you have a margin account that you do not trade in, consider not leaving more securities than are required in your margin account to cover the margin requirement or converting to a cash account and having your securities placed in safe custody.
