Client Money The new CASS regime under the FCA. 26 November 2013

Transcription

1 Client Money The new CASS regime under the FCA 26 November 2013

2 Issues arising out of CP13/5 Ash Saluja 1

3 Scope and timing Revisions to rules on client assets for investment businesses i.e.: CASS 6 (custody assets) CASS 7 (client money) CASS 8 (mandates) Multiple client money pools for EMIR implementation purposes Client distribution rules (CASS 7A) speeding up pay outs Comments were due on bulk of proposals by 11 October 2013 many responses submitted, and FCA still liaising with industry Most changes due to be implemented after 6 month transition period, once final rules published by FCA in H1 2014

4 Remember the policy objective Main goal of CASS regime is to ensure that on insolvency or failure of the firm (a primary pooling event), client assets are easily identifiable and can be returned to clients rather than being claimed for the benefit of all creditors of the firm Risks arise due to: unresolved deficits due to errors or debts (e.g. failure to recognise client assets as such and so comply with CASS) uncertainty over records intra-day/transfer risk (e.g. on the alternative approach/dvp exemptions as not all client money will be in a client account when firm fails) Main objectives of this review are to improve the speed and size of return of client assets following the failure of a firm holding client assets (e.g. by making sure firms records identify all relevant client money)

5 Client money scope of CASS 7 Money received or held by a firm for or on behalf of a client in the course of or in connection the firm s MiFID business or designated investment business FCA is expecting firms to know the basis on which money is held and so when the statutory trust applies Banking exemption: FCA wants banks to be clearer with clients when they rely on this exemption banks must genuinely treat the money as a deposit (e.g. if they do not hold the deposit on their balance sheet and with third party bank, it will be client money) Trustee firms (e.g. SIPP trustees who are also SIPP operator/administrator): currently subject to limited application of certain CASS 7 rules - FCA allowing firms to opt-in to full application of some these (e.g. segregation, records & reconciliations, acknowledgment of trust) clarification that on a primary pooling event, CASS 7A does not apply to monies held under separate trust deed (effectively outside the client money pool)

6 CASS 7 changes receipt and segregation Immediate (rather than prompt) segregation of client money into client accounts for firms not operating the alternative approach (i.e. direct to client account) Must allocate unidentified receipts of client money to specific client(s) within 5 business days Physical receipts (cash, cheques, payment orders) recorded immediately and paid within 1 business day into client money bank account firms may not use to conduct business until cleared Prudent over-segregation (or buffers) to be formalised basis on which money placed in client money bank account has to be clear (i.e. it will be client money rather than firm money) and firms are not permitted to use without clear reason (i.e. specific liability or risk) Use of alternative approach to segregation (where client money is mingled with firm s house money, and transfers are made between house accounts and client accounts on reconciliation) limited to certain multi-currency, multi-product firms who must justify use and put in place appropriate protections (including buffers)

7 CASS 7 changes client money banks Greater onus on appropriate diversification specific factors to be considered enhanced due diligence (financial soundness, deposit protection) Acknowledgement of trust letters FCA now proposes template wording following discussions with the banks to be on firm s letterhead, although arguably better to be on bank letterhead to avoid verification and potential fraud issues counter-signature required from bank to the letter and firm must take reasonable steps to ensure signatory is authorised firms must obtain the acknowledgment BEFORE placing client money in the account (rather than within a 20 business day grace period post account opening) requirements cover client money bank accounts with overseas banks also initial repapering exercise expected within 6 month transition period of rules coming into force firms also expected to review letters annually

8 CASS 7 changes use of fixed term deposits (1) Client money is placed by firms with banks on a fixed term deposit or in notice accounts in order to get a better interest rate either for an individual client (designated account) or clients generally (pooled account) FCA is concerned: that firms will be unable to take action to move client money if they consider the bank is no longer suitable (e.g. change on credit rating, adverse announcement, high potential to fail etc.) if bank fails then a secondary pooling event will occur - clients with a designated account at that bank or clients generally if a pooled account is held with that bank, will suffer as a result If primary pooling event occurs (i.e. firm itself fails) then there will be a material delay in returning money to clients

9 CASS 7 changes use of fixed term deposits (2) FSA raised concerns (questionnaire in August 2012 on term deposits and Dear CF10a letter on unbreakable deposits) and asked firms to (i) review policies and procedures in this area and (ii) confirm to the FSA the details of any unbreakable client money term deposits Proposed prohibition on term deposits/notice accounts where principal cannot be recovered within 1 business day of a withdrawal request FCA considers that clients cannot agree to client money being held in an unbreakable deposit, as a primary pooling event affects all clients with entitlements to the client money pool need to open the account/put the deposit in the client s name so avoiding CASS 7 but falling under CASS 8 Lobby FCA for a practical solution banks need stable funding, large firms will consistently hold a balance of unused client money long term, clients want better interest rates. How can all parties benefit from this arrangement without posing undue risks to clients? Is there an alternative to keeping the deposit in the client s own name which brings operational challenges?

10 CASS 7 changes DVP exemption for CIS Operators of regulated funds do not need to treat subscription/redemption monies as client money under CASS 7 exemption FCA now proposes to remove the DVP exemption: what happens if DVP transaction fails to settle in time? what happens if firm becomes insolvent before transaction has settled? Practical implications how to switch to receiving subscription monies in a client money bank account - many operators use bank accounts that co-mingle DVP money with their own money would they be able to convert those into client money bank accounts or need to set up new accounts and inform investors? How do they cover intra-day positions? would operators seek to act as agents for the CIS (i.e. operate mandates over CIS bank accounts only in accordance with CASS 8 rather than comply with CASS 7?)

11 CASS 7 changes miscellaneous Reconciliations restricted use of standard method 2 (negative add back) Interest: FCA has admitted the draft rules are incorrect (they implied a firm either had to pay all interest on client money balances to a client and treat it as client money, or not pay interest at all on such client money balances) firms can agree contractually the scope and timing of payments of interest to clients (may differ from scope and timing of payments from underlying banks) Transfers of business: FCA now proposing simplified approach for firms seeking to transfer client money to a transferee of their business, rather than needing individual consents/waivers from FCA and having doubts over discharge of fiduciary duty must have an an assignment clause in the relevant contract with the client covering prescribed issues likely most firms will adopt to give flexibility Allocated but unclaimed client money: cannot reclaim for firm s benefit, but can pay to charity subject to formalities for amounts over 10 must give undertaking to make good valid claims

12 CASS 6 proposals Written custody agreements explicit requirement to document arrangements with third parties holding safe custody assets for clients even in an intra-group context further FCA clarification on terms within that agreement New requirements on custody assets reconciliations Unclaimed custody assets: cannot liquidate for firm s benefit, but can pay proceeds to charity subject to formalities for amounts over 10 must again give or procure undertaking to make good valid claims

13 CASS 8 changes mandates Applies when firms control rather than hold client money (e.g. bank account is in the name of client, but the firm has authority to give the bank instructions on making payments and transfers) risk of misappropriation CASS 8 already sets out high level rules that requires a firm to establish and maintain adequate records and internal controls in respect of its use of the mandates Proposal now to include non-written mandates within the scope of these rules covering anything that gives the firm the ability to control the client s assets or liabilities (e.g. telephone instructions passing credit card details etc.)

14 CASS 9 client reporting and information COBS already covers periodic reporting and information on client assets protection to be provided to clients FCA believes there is a lack of understanding amongst clients on client assets issues, as demonstrated by recent insolvencies New proposal for a Client Assets Disclosure Document standalone document does not supersede contractual documentation but acts a single source of the relevant provisions on client assets which impact a client s rights to or interests in such assets provide to clients at least annually if not more frequently if changes occur

15 Multiple Client Money Pools Key proposals to give effect to EMIR: exclude client money that is held by a clearing member firm in a client transaction account at a CCP from a primary pooling event allow the porting of excluded money to a back-up clearing member firm To make porting feasible clearing member firms will be allowed to operate legally and operationally separate client money sub-pools (i.e. the margin held in a particular net omnibus client transaction account at a CCP and the client money the clearing member holds in relation to the relevant transactions) Insolvency practitioners will be able to make the separate client money pool available to the back-up clearing member as necessary FSA had been looking to extend the proposal to permit firms to create multiple client money sub-pools in relation to any investment business but now deemed by the FCA as too difficult for firms to manage operationally

16 Any questions?

17 Proposed changes to the Client Assets sourcebook (CASS) rules: distribution of client money Rita Lowe 16

18 Contents The insolvency regime for investment banks Background to the proposed changes The current rules The proposed changes The "speed" proposal Codifying the existing regime Further proposed changes Reform of the Special Administration Regime 17

19 The insolvency regime for Investment Banks The Special Administration Regime (SAR) Special administration objectives for administrators if unwinding an investment firm s business: Ensuring timely return of client assets and money Engaging with market infrastructure bodies and authorities Winding up or rescuing the firm 18

20 Special Administration Regime (1) At the time of the Lehman collapse, the Special Resolution Regime (SRR) (which deals with the insolvency of deposit taking banks) excluded investment banks. Introduced in February 2011 to provide an insolvency regime for investment banks. In April 2013, a modified version of the SRR was introduced to apply to systematically important investment firms, but the majority of investment firms that are not systematically important will remain subject to the SAR. 19

21 Special Administration Regime (2) The SAR sets out procedures for the rescue or transfer of a failing investment bank s business (based on tried and tested procedures under the Insolvency Act 1986). The CASS Rules on distribution apply to client assets held on statutory trust (created by CASS 7.7). With the exception of trust assets, distribution of assets will be as prescribed by the SAR. 20

22 Background to the proposed changes to distribution rules MF Global & Lehman Brothers insolvencies Return of client money has taken years to achieve Supreme Court Lehman Brothers International (Europe) judgment: A statutory trust arises on firm s receipt of client money Participation in the notional client money pool (CMP) not dependent on actual segregation by firm Primary pooling arrangements apply to client money held in house accounts Supreme Court decision likely to cause further delays in returning money to clients since the insolvency practitioners cannot rely on the firm s records in respect of client accounts 21

23 The current regime CASS 7A CASS rules aimed at achieving the FCA s statutory objectives: Maintaining market confidence Financial stability Consumer protection CASS Rule 7A governs distributions on an investment firm s insolvency Failure of the firm results in a primary pooling event (PPE) where all client money held is notionally pooled into a single CMP CMP then distributed to clients on a pro-rata basis in accordance with their entitlements to the CMP 22

24 FCA proposal (1): the speed proposal Speed is driving the proposed changes New two-stage client money distribution process proposed with two notional CMPs CMP1 and CMP2 Initial distribution of client money held in client accounts based on failing firm s records and within weeks of insolvency from CMP1 Appropriate where IP believes that the records reasonably allow determination of entitlements to be made Second distribution comprised of any surplus left in CMP1 & any identifiable client money held in the firm s house account (CMP2) If two-stage distribution not possible, IP may form single combined CMP and then make one distribution 23

25 FCA proposal (2): codifying the existing regime Alternative to the speed proposal Retention of the current rules with clarification of what money constitutes the CMP Corrected reconciliation carried out at the PPE Procedure set out for determining each client s CMP entitlement 24

26 Other proposed changes Remove current prohibition on CMP being transferred to a purchaser Hindsight used to value client s open position when determining entitlement to the CMP Unclaimed client money may be used to make up shortfall in CMP Client money received after a PPE should be placed in client accounts opened after the PPE Client money in individual accounts should not be pooled if a central counterparty fails Remove requirement to notify FCA when firm becomes aware of failure of third party holding client money 25

27 The Special Administration Regime Review The FCA review co-ordinates with a separate review of the SAR. Interim Bloxham report recommends SAR should be retained with some amendments Full report due out soon, and is likely to include further proposals in relation to client money and assets. 26

28 Conclusions FCA proposed changes to the distribution regime aimed at speeding up return of client money and assets for insolvent investment banks / firms may be implemented during early 2014 Some proposed measures may not be implemented if changes are made to the SAR following full publication of the Bloxham report The Bloxham report on SAR is likely to have a greater impact on the efficiency of the distribution regime than current FCA proposals Importance of ensuring record keeping is accurate. 27

29 Any questions?

30 The FCA focus on CASS compliance and the consequences for firms Alison McHaffie 29

31 The FCA focus on CASS compliance and the consequences for firms Looking at. Supervisory focus Reporting CASS breaches Lessons to be learnt from recent Enforcement activity 30

32 An FCA Supervisory Focus An FCA operational objectives is to secure an appropriate degree of protection for consumers Focus on the protection of client assets is not new: Compliance officer letter 2009 and Dear CEO letter 2010 Specialist Client Asset Unit 2010 further resourced Introduction of CF10a function CMAR and Auditor s Client Asset Report The review of the CASS regime and CP13/5 We will continue our intensive and intrusive approach to identify and mitigate CASS risks Increasing firms compliance and awareness of CASS rules is a key aim for us in 2013/14. (FCA business plan 2013/2014) FCA will do this by: Increasing the supervision of firms holding client money and safe custody of assets through more intrusive visits to firms, thematic projects and desk-based reviews, actions initiated through CMAR /audit information and taking regulatory action where firm failings are identified. Embedding its risk assessment and prioritisation method, using the information given to it by firms through CMAR audits, and combining this with firm intelligence 31

33 What if you identify a breach of CASS? Identify: What has gone wrong? How big/significant it is? Length/frequency of breach? Evidence of any weaknesses in controls? Is remedial action required Notify FCA depending on significance/ materiality of breach: Principle 11 anything which the regulator might reasonably expect notice SUP R significant breach of rule CASS R - without delay... if not complied with, or is unable, in any material respect, to comply with the requirements in CASS 7.6.1R [or] CASS 7.6.2R Ensure self reporting is prompt, clear and provides assurance that management is in control and appropriate remedial action is being taken Audit report Consequences of failure 32

34 What goes wrong (1) - lessons learned Proper handling of client money is essential in ensuring that markets function effectively. Where they fall short of our standards, firms should expect the FCA to step in and take action to avoid a poor outcome for their clients, and ultimately, consumers Tracey McDermott Director of Enforcement Where we find that firms do not have adequate systems and controls in place to ensure the safe segregation of client assets, we will consider taking enforcement action 2013/14 Business Plan Triggers for action: Risk of loss to customers and risk of set off by banks Risk of delay in return of money Failure to heed warnings False attestations 33

35 What has gone wrong? Breaches of Principle 10, Principle 3, and CASS Failure to: Segregate and comingling with firm s own funds Carry out sufficient due diligence on institutions holding monies Recognise firm is holding client money Obtain trust letters Perform client money calculations and reconciliations accurately and promptly Inadequate records to distinguish one client s money from another s Manage acquisitions and re-organisations so that CASS oversight and compliance is weakened Oversee TPAs Poor management oversight and MI Carry out sufficient enquiries before providing affirmations to FCA 34

36 Penalties Old regime 1% of average client money balances New regime for breaches post March 2010 (since Xcap June 2013) Level of seriousness Percentage Client Money Percentage Safe custody assets Level Level Level Level Level Will result in higher fines Risk of individual action against senior management where there is personal responsibility for failings Publication of Warning Notices Most cases settle 35

37 How to handle an investigation Some practical points Seeking to avoid an enforcement referral Robust systems and controls kept under review Awareness of regulatory developments and actions Prompt and effective notification of any breaches Firm identifies and carries out remedial action on own initiative No risk of loss or delay Good and constructive relationship with supervisors Managing an investigation effectively Prompt and well ordered response to requests for information and well prepared interviewees Put issues in context and show actions were reasonable Seek to understand Regulator s concerns and address them early in the process Demonstrate lack of risk to customers monies consider expert IP evidence Show lessons learned and acted on by firm 36

38 Any questions? 37