Cyprus: Consultation On New Procedures For Safeguarding Funds Of Clients Of Cyprus Investment Firms

The Cyprus Securities and Exchange Commission ('CySEC') has issued a draft circular for consultation with Cyprus Investment Firms ('CIFs') and other stakeholders setting out proposed changes to and clarifications of the detailed procedures to be followed by CIFs in order to fulfil their obligations with regard to safeguarding of clients' funds. The consultation period runs until 18 November.

Article 18(2)(j) of the Investment Services and Activities and Regulated Markets Law of 2007 as amended provides that, 'a CIF must, when holding funds belonging to clients, make adequate arrangements to safeguard the clients' rights and, except in the case of credit institutions, prevent the use of client funds for its own account'. Part VI of CYSEC Directive DI144-2007-01 of 2012 sets out the current detailed procedures.

According to section 18(1)(e) of the Directive, CIFs must ensure that clients' funds are held in accounts identified separately from any accounts used to hold funds belonging to the CIF. In order to comply with this requirement, and in particular to safeguard against clients' funds being used offset other obligations under banking "set-off" arrangements, CIFs may not deposit clients' funds in an account with any person in any jurisdiction unless they have a written confirmation from the person concerned acknowledging that all funds standing to the credit of the account are held by the CIF as trustee (or if relevant, as agent) and that the person is not entitled to combine the account with any other account or to exercise any right of set-off or counterclaim against money in that account in respect of any sum owed to it on any other account of the CIF. CySEC will publish the prescribed wording required.  In addition, the title of the clients' account must sufficiently distinguish it from any account used to hold funds belonging to the CIF.

If the law of the jurisdiction in which the client funds are held prevents the CIF from complying with these requirements the CIF must satisfy CySEC that it had no other alternative but to conduct such business, given the risk to clients' funds in the event of the Person's insolvency, and that it took everything in its powers to obtain separately titled accounts, including using another third party. If it is not satisfied that clients' interests are adequately safeguarded, CySEC may require the CIF to set aside an equivalent amount of its own funds in a segregated account elsewhere.

Clients' funds may be transferred to another person, such as an exchange, a clearing house, a liquidity provider or market maker, or an intermediate broker, only if the recipient is appropriately licensed and regulated in its home country, and the funds are transferred for the purposes of a transaction on behalf of the client carried out through or with that person, or to meet the client's obligation to provide collateral for a transaction (for example, an initial margin requirement for a contingent liability investment). Before transferring the client's funds, the CIF must notify the proposed recipient that the CIF is obliged to keep clients funds separate from its own funds, placing them in a client bank account, and instruct the recipient that any funds paid to it in respect to that transaction is to be credited to the client's transaction account. The CIF must obtain written confirmation from the proposed recipient, in a form specified by CySEC, that the client's transaction account is not to be combined with any other account, nor is any right of set-off to be exercised by that person against funds credited to the client's transaction account in respect of any sum owed to that person on any other account. Retail clients should also be notified in advance that their funds may be transferred to another person, by way of an appropriate disclosure in the CIF's terms of business or a specific notification. The CIF remains responsible for its clients' funds, irrespective of having transferred them to another person.

CIFs may not use clients' initial margin as collateral when they transact in their own name or hedge their open trade positions. If such collateral is required, CIFs must use their own funds and not clients' funds.

CIFs are required to put in place robust and adequate administrative and internal control procedures to safeguard clients' funds. They must exercise due skill, care and diligence in the selection, appointment and periodic review of person to which clients' funds are entrusted and in the arrangements established for the holding of those funds. There must be adequate segregation of duties, with at least two signatories being required.

CIFs are also required to perform regular reconciliations between their own accounts and records of client funds and the records (such as bank statements or account statements) provided by any third parties by whom those assets are held. In determining the appropriate frequency of reconciliations CIFs should take account of the risks to which their business is exposed, such as the nature, volume and complexity of the business, and where and with whom the clients' funds are held. If transactions are undertaken on a daily basis, reconciliations of clients' funds should be conducted each business day in order to ensure that funds held are equal to amounts owned to clients. CIFs must report client balances to CySEC in the prescribed form at the end of each quarter. The reports for the quarters ended 30 June and 31 December must be supported by a report from the CIF's external auditor. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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