According to the FSA paper, credit writebacks arise for various reasons but generally represent net overpayments to insurance or reinsurance intermediaries and unclaimed balances held on behalf of customers, insurers, reinsurers and all third parties.
For some time it has been the practice of intermediaries to seek to write those balances back out of the client money accounts into the intermediary's own account. The FSA's paper discusses the circumstances in which that type of action is acceptable and warns that intermediaries will have to justify their decisions.
The FSA's intention appears to be to ensure that any sums transferred out of the client money accounts are transferred for good reason and that there is no breach of trust law or, indeed, the directors' obligations to properly account for transactions, assets and liabilities. The extent to which intermediaries should investigate balances was not obvious.
The FSA acknowledges that there are instances where balances held in the client money account have arisen through incorrect or incomplete accounting. Where that is the case it should be corrected.
It also highlights, however, that there may be balances in the client money account which consist of long-standing legacy items. Where that is the case, the directors of a firm should assess whether there is sufficient evidence to allow a credit writeback.
Helpfully, the FSA sets out the considerations that an intermediary should take into account. They include:-
- the quality of the firm's systems and controls (for the relevant period);
- the degree of due diligence reasonably capable of being carried out to identify the monies and their ownership;
- whether the monies in the client account have the potential to impair the trust status of the account; and
- the extent to which these monies relate to legacy or pre-regulation transactions and balances.
The FSA makes clear that, if firms are not able to provide evidential due diligence, they should state why and how they are otherwise able to satisfy that monies would be due and payable to the firm.
The paper sets out the types of evidence that might be expected, including:
- satisfying auditors as to the appropriateness of any credit writebacks in the context of fair presentation of financial statements set out in Generally Accepted Accounting Principles ("GAAP");
- independent written legal opinions on the appropriateness of any credit writeback;
- compliance with documented credit writeback procedures;
- copies of written communications to insurance creditors or their agents;
- details of the age of the balances, i.e. when they were last active; and
- resolutions to confirm that the relevant writeback is not essential for the regulated entity to meet Threshold Condition 4.
The paper makes clear that the FSA may well ask for records relating to cash transfers out of the client money account. If there are poor systems and controls and there are inappropriate credit writebacks, then the FSA may well take regulatory action . It is important, therefore, to ensure that any credit writebacks are properly supported by persuasive evidence, which must be kept for at least three years post-transaction.
Importantly, the FSA warns that unmatched cash may mean that intermediaries are not complying with the client money rules and may also be in breach of Senior Management Arrangements Systems and Controls 3.2.
That rule sets out the areas to be covered by an intermediary's systems and controls appropriate to its business such as reporting, compliance, management information, its internal audit function and the maintenance of appropriate records.
The FSA makes clear that each firm must ensure that senior management and staff are competent and aware of the procedures and their responsibilities in relation to the handling of client money. The paper does not make clear the position in relation to credit writebacks that took place before the current statement and whether those intermediaries that have undertaken credit writebacks to date should now review their work and positions.
The release of the paper highlights the FSA's resolve to ensure that intermediaries address unmatched cash and balances in a proper fashion, giving reasons and persuasive evidence why credit writebacks have been or should be undertaken.
Unmatched balances have remained a problem area, particularly in respect of balances arising prior to regulation of intermediaries by the FSA in 2005. These legacy issues can arise after mergers, acquisitions or the run-off of a line of business.
There now is regulatory impetus to resolve them within a better-defined framework. In particular, writebacks should be made in the context of GAAP, as well as the fact that client money accounts are trust accounts, such that those considering writebacks should give attention to their duties under trust law.
Certainly, this is an area that the FSA will now focus on when conducting reviews, in particular where it has concerns about capital adequacy of intermediaries.
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.