UK: PS 14/09 "Review Of The Client Assets Regime For Investment Business"

Last Updated: 27 June 2014
Article by Paul Leech

Most Read Contributor in UK, August 2017

PS 14/09 "Review of the Client Assets Regime for Investment Business" (the 'PS'), the FCA's response to CP 13/5 (the 'CP'), was published on 10 June and amends large elements of the client money and custody asset (CASS) rules.  It excludes most elements of the CP relating to the return of client assets following a 'pooling event' which are expected to be the subject of further consultation following the current review of the Special Administration Regime.

As it title says, PS 14/09 sets out the long awaited conclusions from a review of the client assets regime for investment business.  Since the issue of the CP in 2013 firms have been considering the potential impact of the proposals on their business.  The final changes to the client assets rules are far-reaching, contain changes to what was originally proposed, will almost certainly affect all investment firms holding client assets and for many firms will require significant changes to their policies, procedures and systems.

Firms and trade association had requested that there should be a sensible timescale for implementation of the changes and to some extent this is reflected in the way the revised rules are being brought into force.  Some changes come into effect on 1 July 2014, although most of these are only clarifications of the current rules.  A new requirement from 1 July 2014 is a restriction on client money being place on unbreakable terms deposits greater than 30 days.  The majority of changes are effective from 1 December 2014 or 1 June 2015.  Of the rules effective from 1 December 2014 many have a six month transitional period for existing relationships.  However, the FCA has also indicated that a firm may from 1 July 2014 implement any of these later changes in the policy statement at an earlier date if they wish (paragraph 2.16).  Table 2 in Chapter 2 of the PS does provide a useful summary of the commencement date of the changes and transitional provisions.

We set out below some of the areas where, for better or worse, the PS has amended the proposals set out in the CP.  It is not an exhaustive analysis at this stage and further detailed consideration of the new rules may identify additional areas of interest.  We have also highlighted some areas where although no significant change to the original proposal have been made, there are challenges to firms and the industry in implementing the requirements.

Custody Assets Reconciliations

The final rules mean all firms that hold custody assets will be required to undertake an 'internal custody record check' being either an internal custody reconciliation or an internal systems evaluation (paragraph 5.32).   In addition, firms will need to carry out a physical assets reconciliation (if applicable) and an external custody reconciliation.  Whereas the CP proposed that a firm must get a confirmation from an independent auditor before using a 'non-standard' method of internal client assets reconciliation, the PS removes this requirement in respect of the 'internal custody record check' (paragraph 5.34) although the adequacy of such systems will be reported on as part of the client assets report by the CASS auditor (paragraph 5.60).

To use the 'internal custody reconciliation method' firms will need to maintain two sets of internal records, a 'client-specific safe custody asset record' and an 'aggregate safe custody asset record' (paragraph 5.44).  Even to use the 'internal system evaluation method' a firm will need at least one set of its own records.  Paragraph 5.51 of the PS states "The revised recordkeeping rules being introduced in this PS also clarify that the records firms arerequired to maintain in respect of custody assets must be internal records of the firm which are separate to any records the firm may have obtained from any third parties, such as those with whom it may have deposited, or through whom it may have registered legal title to, custody assets."

There is discussion within the PS about discrepancies arising from reconciliations and how firms may segregate money instead of assets where appropriate.  While the segregation of money in lieu of assets has been around for some time the PS reminds firms of certain considerations, namely whether the firm has permission to hold client money, whether the client is entitled to client money protections and whether the agreement with the client needs amending to reflect this segregation (paragraph 5.88 etc.).  While firms may have gone through the process of segregating money instead of assets in the past, in many cases it will have been a desire to protect an appropriate amount which took priority rather than going through these 'hoops' beforehand.

Client Money reconciliations

The PS contains some 60 paragraphs discussing client money reconciliation requirements many of which are in line with the proposals in the CP.  It is pleasing to note that the two standard methods of internal client money reconciliation have been retained, albeit with a restriction on who can use the 'net negative add back' method.  While the 'net negative add back' method for the internal client money reconciliation has been retained for most assets management firms it is clear FCA do not consider this a proper method and have indicated that they may consult on removing this in the future (paragraph 7.249).  Firms may wish to consider how they may be able to develop their systems to use the other standard method 'individual client balance'.

In respect of the 'individual client balance' method, FCA will allow firms to calculate each individual client balance on a product-by-product or business line basis instead of the previous requirement for it to be based on the entire firm's holdings for an individual client (paragraph 7.257).  FCA recognises this may lead to some over segregation as firms will not be netting out client's negative and positive positions across products and accounts.  However, as long as the process is clearly documented and the firm sets out its reasons for operating this way, it is consider a suitable reconciliation approach.

It should be noted that the PS confirms that external client money reconciliations will be required at least monthly but for those firms that undertake daily transactions in client money a daily external client money reconciliation is required. (paragraph 7.263).

Title Transfer Collateral Arrangements

While no major change has been made to the proposals around Title Transfer Collateral Arrangements (TTCAs) the final rules do make it clear that the arrangement must be set out in a written agreement covering "the client's agreement to the terms of the TTCA, any terms under which ownership of the client's assets or monies may transfer back from the firm to the client, and any terms for the termination of the TTCA or for the overall agreement through which the TTCA was agreed." (paragraph 6.12)

DvP Window – Commercial settlement systems

In respect of the DVP window for transactions settled through a commercial settlement system the basic requirements have not changed but the rules will require a firm to ensure each client agrees to the holding of its assets or monies within the DvP window (paragraph 6.30).  The agreement needs to be documented in writing and retained for the duration of the time that the firm uses, or intends to use, the DvP window in respect of transactions for that client.  In many cases it is likely to mean that client agreements will need updating to reflect this.

DvP window – Regulated Collective Investment Schemes

The CP proposed the complete removal of the DvP arrangements for regulated collective investment schemes but following much industry lobbying the window has been reduced from four days to one (paragraph 7.42) rather than removed completely.  The wording of the one day window is different to that of the four day window, being based largely on when money or assets are received, so it may in some respects be more useful than at first sight.  However, it is a change which is likely to require considerable thought on the part of administrators and others who use the window to avoid the need to hold client money.  While only occasional breaches may have arisen with a four day window a more significant number are likely to arise with only a one day window and some firms will need to consider carefully whether they need to amend their permissions to reflect this.

A further downside is the requirement for firms to evidence a client's agreement to the use of the DvP CIS window, which might be possible by amending a client's terms of business. (paragraph 7.49).  Another factor which may have slipped under the radar is the requirements for redemption cheques to be drawn on a client bank account and presumably protected as client money until presented. (paragraph 7.48).  Reading between the lines it seems FCA would still like to remove the DvP CIS window and may well revisit this in the future.

Paying away to charity 'de minimis' amounts of unclaimed client money

One of the more pragmatic changes as a result of feedback to the CP is the increase in the amount of unclaimed client money that can be paid away under the 'de minimis' rules.  Originally proposed as amounts less than £10 this has been increased to £25 for retail clients and £100 for other clients.  The figures may assist those firms who wish to remove such small amounts from their reconciliation processes. (paragraph 6.63.)

Unbreakable Term Deposits

The introduction of a 30 day limit for client money on unbreakable term deposits (paragraph 7.102) goes someway to pacifying those who were concerned about the implications of the proposals in the CP to stop the use of unbreakable term deposits altogether.

It is interesting to note that the removal of the restriction on ISA money being held in unbreakable term deposits set out in CP 14/09 "Client Money held in Individual Savings Accounts" is similar to that set out in paragraph 7.33 of the PS in respect Trustee Firm Client Money, namely that the restriction on unbreakable terms deposits to a 30 day term does not apply.  Thus allowing money held in SIPPs by the trustee of that SIPP to be place on long term deposits.

Acknowledgement Letters

Trust acknowledgement letters for client money bank accounts will need to be in a standard form and on firm headed paper for both UK and non-UK accounts. (paragraphs 7.285 and 7.315).  All accounts will need to include the term 'client' in their title and be specifically identified in the body of the acknowledgement letter.  Firms will have until 1 June 2015 to re-paper existing letters.

A firm will not be able to put client money into a new client money account until a signed acknowledgement letter is received back from the bank concerned.  The 20 day grace period for UK accounts and the 'flexibility' on non-UK accounts will no longer apply (paragraph 7.307).  A variation of these requirements is available in respect of accounts at CCPs. (paragraph 7.325).

A firm should be able to demonstrate how it has concluded that a particular individual who has countersigned an acknowledgment letter was authorised to do so and should expect FCA to challenge its conclusions (paragraph 7.337).  Care will be needed in complying with the requirements for money placed on overnight deposit and the need for an 'established relationship' with the banks concerned (paragraph 7.343).

CAMPSA

We are no doubt all intrigue by the introduction of 'CAMPSA' – Clearing Arrangement Mandatory Prudent Segregation Amount (paragraph 7.121) – by clearing firms in respect of the use of house accounts for mixed payments and receipts.  An amount in respect of CAMPSA will need to be 'calculated and adjusted' at least quarterly.

Cleared Funds

The proposals in the CP around the use of cleared funds generated much discussion and concern and FCA are to be thanked for taking these concerns on board in a way which it is to be hope can be adopted by firms.  In paragraph 7.136, FCA describes their approach as "instead of creating a general restriction on the ability of firms to undertake business for clients with their money until that money has cleared into a client bank account, the final rules set out explicit guidance that states that a firm should ensure its organisational arrangements are adequate to minimise the risk that client money held by the firm may be paid for the account of a client whose money is yet to be received by the firm."  Leaving the way this is achieved very much to the firm to decide, along with an appropriate supporting policy and documentation of course.

Independent Auditor reports

Whilst a report is not required for a non-standard client assets reconciliation it is still required for the use of the Alternative Approach to client money segregation (Paragraph 7.173) including a reconfirm for those that currently use this approach reflecting the impact of new requirements imposed by the PS, in particular the MPSA (Mandatory Prudent Segregation Amount).  Firms will be required to calculate the MPSA at least every quarter (paragraph 7.185).

Record Keeping

A number of record keeping requirements have been clarified or amended.  As an example, FCA will expect firms to be able to determine the total amount of client money they should be holding for each client within two business days of having taken a decision to do so, or at the request of the FCA. (paragraph 7.209).  While some firms will have systems that do this, some organization may face a challenge in creating what is effectively a 'single customer view'.

 Client Assets Disclosure Document

Some firms will be pleased that the Client Assets Disclosure Document (CADD) has been put on the back burner, at least for the time being (paragraph 9.31).  Unfortunately FCA have not ruled out further consultation on the "topic of reporting and providing information to clients on client assets" (paragraph 9.33).

No new Sourcebook – yet

And finally, we will not have a new CASS Sourcebook but rather a significant re-organisation of the current rules to makes them simpler and easier to follow.  The re-organisation going to the extent of a complete renumbering of Chapter 7 effective from 1 June 2015 (paragraph 10.12).

Conclusion

Many of the changes are designed to provide information to clients to make it clearer exactly how and when they are protected by the CASS rules and when they are not (TTCAs DvP windows, banking exemption).  Other changes are designed to make it easier for clients' assets to be return following a pooling event.  The overall objectives of enhancing the client assets regime to achieve better results for consumers and increase confidence in financial markets (paragraph 1.1) may be supported by these changes but they come at an implementation and ongoing cost to the industry, some of which is likely to be paid for by clients in increased charges.

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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