PS 14/9: Review of the client assets for investment business BEST PRACTICE STATEMENTS CASS

PS 14/9: Review of the client assets for investment business BEST PRACTICE STATEMENTS CASS

Table of Contents 1. Introduction... 1 2. Cass 6 Custody Asset Rules... 2 2.1 Registration of firm assets and custody assets... 2 2.2 Custody recordkeeping, record checks and reconciliations... 3 2.3 Recordkeeping and notifications... 6 2.4 Handling discrepancies and shortfalls in custody assets... 7 3. CASS 7 Client money rules... 7 3.1 DvP exclusion for commercial settlement systems... 7 3.2 DvP exclusion for collective investment schemes... 8 3.3 Money ceasing to be client money... 10 3.4 Transfer of business handling client money... 11 3.5 Client bank accounts due diligence and diversification... 11 3.6 Immediate segregation... 11 3.7 Physical receipts and allocation of money... 12 3.8 Cleared funds... 12 3.9 Allocation of client money receipts... 13 3.10 Client money record keeping and reconciliations... 13 4. CASS 8 Mandate rules... 15 4.1 Non-written mandates... 15 5. CASS 9 Information to clients... 15 5.1 Information to clients on safeguarding client assets... 15 6. Important Information... 16

1. Introduction Following detailed analysis of Consultation Paper CP13/5 by the TA Forum CASS Working Party, the FCA published Policy Statement PS14/9: Review of the client assets regime ( PS ) for investment business on 10 June 2014. The PS changes have taken place in the following three phases:- 1 July 2014 Certain rules and guidance came into force which provided clarification of existing requirements. These included limiting the placement of client money in new unbreakable term deposits and the introduction of the option to operate multiple client money pools. 1 December 2014 Rules and guidance came into force on the provision of information and consent obligations when entering into custody agreements with new investors and the documentation of agreements and arrangements with any new counterparties with whom firms deposit or otherwise place custody assets or client money. These new obligations included a requirement to notify the investor of certain matters if operating under the banking exemption and mandating the use of template acknowledgement letters with new client bank and client transaction accounts. 1 June 2015 All of the remaining rules and guidance came into force and all regulated firms need to ensure they are fully compliant with all of the new rules. On receipt of the PS, the TA Forum CASS Working Party carefully reviewed its contents before holding a series of workshops with both its members and the FCA to fully understand the implications of the new rules, how they would impact transfer agents and the administration activities conducted (on behalf of regulated firms) and where possible, agree an industry interpretation/application of the new rules. This document provides industry best practice in respect of the key changes outlined in the PS which affect the administration activities performed by UK transfer agents on behalf of regulated firms ( firm/firms ). This document is subject to continued review and at the time of publication contains the current view of the TA Forum CASS working party members. The requirements referenced in this document are not intended to be exhaustive and other requirements on firms may exist. Certain details within this Best Practice statement will be at a relatively high level, given the differing systems operated by TA Forum members and the differing contracted services between clients. CASS Page 1

2. Cass 6 Custody Asset Rules 2.1 Registration of firm assets and custody assets Rule(s): 6.2.3R and 6.2.6G A firm s ability to register title to its own assets in the same name as any custody assets registered in the name of a nominee will be restricted to circumstances in which this is necessary to facilitate a client transaction (e.g. in handling dealing errors, allocating bulk deals and/or processing transactions in fractional shares) or as a result of the law or market practice of an overseas jurisdiction. The TA Forum CASS Working Party is of the view that the following examples under CASS 6.2.5R (1) will be permissible in the course of a firm performing designated investment business for the account of any client: i) correcting dealing or transaction errors; ii) processing or allocating assets for bulk deals (rounding mechanisms); iii) maintaining a small balance of firm's own assets for purely operational or compliance purposes (float for breaks); iv) allowing clients to trade in fractional shares; v) make good a shortfall There is an apparent conflict between these rules and an ability for ISA wrappers to hold assets in the name of the firm. Upon consultation with the FCA, the TA Forum CASS Working Party concluded that the new rule puts the onus on the Plan Manager to meet both sets of rules. For Investment Trusts, Equities & Structured Products, TA Forum members will reconcile to the Custodian. Reconciliation between the Custodian and CREST, or any other commercial settlement system, will not generally be a TA Forum member responsibility. CASS Page 2

2.2 Custody recordkeeping, record checks and reconciliations Rule(s): 6.6 Records, accounts and reconciliations Rules have been updated to accommodate firms that use integrated systems to maintain their records for custody assets; the amended rules also introduce a minimum frequency at which firms are required to undertake reconciliations or perform other checks to ensure the accuracy of their records for custody assets. Before deciding on the most suitable method of reconciliation, a firm must decide the most appropriate method of custody asset reconciliation for the business operated. The methods are: Internal Custody Reconciliation Method - where client specific and aggregate level holdings are comparable and separately maintained. As the data sources for two sets of information come from different sources these two sets of holdings can be compared against each other in order to identify any differences. Internal System Evaluation Method - where the client specific and aggregate level holding are not maintained independently of one another or where there is only one record rather than two. As the data source for the two sets of information are maintained via the same system and driven by the same data, the firm must put in place adequate checks and controls to ensure that the transactional information sent is being input and maintained correctly to ensure no errors occur on client level holdings and at the aggregate level. It is expected that most TAs only perform the internal system evaluation method where the internal custody reconciliation method cannot be operated. As per 6.6.19 R The internal system evaluation method requires a firm to: (1) Establish a process that evaluates: (a) the completeness and accuracy of the firm s internal records and accounts of safe custody assets held by the firm for clients, in particular whether sufficient information is being completely and accurately recorded by the firm to enable it to: CASS Page 3

(i) comply with CASS 6.6.4R; and (ii) readily determine the total of all the safe custody assets that the firm holds for its clients; and (b) whether the firm s systems and controls correctly identify and resolve all discrepancies in its internal records and accounts of safe custody assets held by the firm for clients; (2) Run the evaluation process established under (1) on the date of each internal custody record check; and (3) Promptly investigate and, without undue delay, resolve any causes of discrepancies that the evaluation process reveals. Frequency of the custody record checks When determining the frequency at which it will undertake its internal custody record checks under CASS 6.6.11R, physical asset reconciliations under CASS 6.6.22R, and external custody reconciliations under CASS 6.6.37R, a firm must have regard to: (1) the frequency, number and value of transactions which the firm undertakes in respect of clients safe custody assets; and (2) the risks to which clients safe custody assets are exposed, such as the nature, volume and complexity of the firm s. It is the TA Forum CASS Working Party s view that the frequency of the internal custody record check should be considered in the light of the pricing point frequency of the asset if internal records are available to do so. External custody reconciliations must be carried out as regularly as is necessary, but at least on a monthly basis. It is the view of the TA Forum CASS Working Party that the external reconciliation should take place as frequently as the external statement is readily available. It is the view of the TA Forum CASS Working Party that, ultimately, the firm must determine the frequency of the internal custody record check and external reconciliation. Scope of the Internal System Evaluation Method A firm has the responsibility under these requirements to evaluate a system that supports processes it has outsourced, and therefore certain assurances and data will be required from the TA in order that the firm may undertake an additional level of review, to demonstrate that the controls established over client level dealing and custody records are operating as intended, and have the scope to deliver the right outcomes. CASS Page 4

The purpose of the ISEM is to provide an overview to substantiate that errors in the custody asset record are being identified and resolved within that controlled environment. It is the view of the TA Forum CASS Working Party that the overall risk and control environment should be fully documented at the outset. The AAF01/06 and ISAE3402 reports on internal controls which should include a Service Auditors Assurance and details of the Service Auditors test of the operating effectiveness across the TA business should be referenced in the ISEM documentation. To further enhance the risk and control detail, members should consider using details of any risk review or control oversight such as process overview documents and procedures that detail key controls, risk assessments and process maps. The ISEM should also consider the potential that the technology system as a whole is not delivering the processing as designed and specified. Whether because of an IT error within the system itself; or in the way the system relays data to other parts of the IT infrastructure. When considering IT Errors the ISEM should be able to: Demonstrate the controls around accuracy of hand-offs between systems; Demonstrate that the overall integrity of the IT solution is being maintained, including the monitoring of batches and jobs to ensure there are no failures or issues. Demonstrate processes and procedures around responses where issues have been found in the production environment by the operational teams. Ensure that system records are only affected within the agreed controlled parameters and by those who have the authority to do so - based on their role, the training received, and the oversight under which they operate. It is not expected that the control environment, to include the technology system are tested in line with the timelines set out for running the Internal System Evaluation, but rather to be able to demonstrate that no changes have been made that would affect the integrity of that environment. The majority of BAU activities performed by TA systems are standardised processes that deliver a pre-determined and automated set of postings to the relevant set of accounts. Therefore, the risks that must be recognised by the ISEM are: The risk that such a standard process does not operate as intended; and CASS Page 5

The risk that a User performs a task without using the standard process. Whether due to user error, or because of a known system functionality / performance problem that requires the use of an alternative process. The data is robust The systems and controls are operating effectively and as expected The ISEM should clearly demonstrate and evidence that controls are in place in order to mitigate these risks and all contingencies are effective and reviewed and tested and performed with the necessary regularity. 2.3 Recordkeeping and notifications Rule(s): 6.6 Records, accounts and reconciliations Enhanced rules have been introduced relating to recordkeeping requirements. A firm will be required to make and retain copies of each custody record check and/or reconciliation the firm undertakes, each review it conducts of these arrangements and its policy and procedures for complying with the FCA requirements, including those around recordkeeping and reconciliations. Where a firm will be unable to comply with a specified requirement, either continuously or for a specified period, or where the firm materially fails to comply with a rule the firm will be required to notify the FCA. Materiality thresholds will apply to actual breaches, meaning not all breaches need to be notified to the FCA. What is material will depend on the circumstances and firms will need to consider this on a case-by-case basis. It is the view of the TA Forum CASS Working Party that firms will need to ensure that internal records are maintained for arrangements, policy and general CASS governance. As part of standard transfer agency services, a transfer agent will record the following:- i) each review it makes of arrangements ii) policies and procedures incl. record keeping and reconciliations iii) materiality thresholds iv) client specific records v) notification requirements to be in line with client money rules CASS Page 6

2.4 Handling discrepancies and shortfalls in custody assets Rule(s): 6.6 Records, accounts and reconciliations The new rules clarify the obligation on firms to fund shortfalls for custody assets only for which they are responsible (using a firm s own assets or, where appropriate, other funds). The rules also introduced more detailed notification and recordkeeping requirements (including requiring firms to maintain internal procedures and policies for their custody reconciliations). A firm will be required once identified to resolve a stock discrepancy without undue delay by ensuring all reasonable steps have been taken to investigate & resolve the discrepancy. If the discrepancy cannot be resolved a firm will need to make good the shortfall with its own assets or cash equivalent as part of the daily client money reconciliation as soon as it has been identified on the internal or external reconciliation. When covering a shortfall using a firm's own money, a firm will have to revisit the valuation each day to ensure it is segregating the right amount of client money. Where a firm concludes that another party is responsible for the discrepancy, it will need to take all reasonable steps to quickly resolve the situation with the relevant party, until which time that the other party has agreed responsibility for the shortfall and made it good, the firm should continue to cover the discrepancy. 3. CASS 7 Client money rules 3.1 DvP exclusion for commercial settlement systems Rule(s): 6.1.12R to 6.1.12ER and 7.2.8AG to 7.2.8AER Rules(s): 6.1.12R to 6.1.12ER and 7.11.14R to 7.11.20R Date effective: 1 December 2014 and June 2015 The rules set out when a firm is allowed to cease treating money as client money or cease to apply the custody rules to a custody asset, as applicable, while carrying out a delivery versus payment ( DvP ) transaction through a commercial settlement system and ensure clients agree to these arrangements. The TA Forum CASS Working Party are currently in discussion with the Settlement System providers with regards to which settlement systems and transactions meet criteria for CSS exemption, the following reflects the current understanding of the TA Forum CASS Working Party:- CASS Page 7

CREST Have confirmed that FCA deems they meet the criteria for Equities and Bonds, but confirmation outstanding regarding CIS. CREST understood to be in discussions with FCA to confirm. Calastone The TA Forum understands that Calastone believe they meet the criteria and are seeking such confirmation from the FCA. Clearstream The TA Forum understands that Clearstream believe they meet the criteria and are seeking such confirmation from the FCA. The TA Forum awaits the outcome of the above discussions before being in a position to devise best practice statements for DvP for Commercial Settlement Systems. 3.2 DvP exclusion for collective investment schemes Rule(s): 7.11.21R to 7.11.24R The FCA originally consulted on the removal of the DvP Exemption but acknowledged the challenges this would pose to the industry. The rules in PS14/9 therefore permit the use of a new, DvP Exemption. If money is not, by COB on the business day following receipt, passed to Trustee / Depositary, the firm / ACD must segregate. There is no requirement to protect redemption monies before the firm/acd receives them. If redemption monies not paid by COB on the business day following receipt, the firm/acd must segregate. The following model represents the TA Forum CASS Working Party s best practice:- CASS Page 8

A summary of activities: All investment cheques received will normally be banked into a Client Money account Electronic receipts received on or after contractual settlement date of a valid buy deal received into a non-client Money bank account do not require Client Money protection Protection of electronic receipts received more than one business day before contractual settlement date will require protection in a Client Money account Protect unidentified electronic receipts in a Client Money account BACS direct debit collections to be collected into a Client Money account Cheque redemption payments to be made from a Client Money account CASS Page 9

Electronic redemption proceeds to be paid from a non-client Money account on contractual settlement date (CSD). This includes regular repurchase payments by BACS. Electronic redemption proceeds unpaid after contractual settlement date to be protected in a Client Money account until payment effected (regardless of renunciation or AML status). Electronic payment after contractual settlement date can be made from a firm s account as long as the equivalent amount remains protected in a Client Money account until the payment has been made, and the equivalent removed from Client Money as soon as is practicable (no later than the close of the following business day). Any redemption proceeds paid by cheque that cannot be settled to the investor are to be protected in Client Money from contractual settlement date (regardless of renunciation or AML status). Switches between funds with differing contractual settlement dates to have Client Money treatment as per investments and redemption monies i.e. contractual settlement date used as the point where assets and cash are exchanged redemption proceeds received prior to buy proceeds to be offered protection in Client Money. For example where the redemption deal has a T+2 Contractual Settlement Date and where the buy deal has a T+4 Contractual Settlement Date. A non-client Money bank account can be utilised for market settlement (to or from a trustee for example). Investor Consent The use of terms and conditions by firms to advise investors of the new DvP Exemption is permitted under the new rules, unless firms have existing contractual arrangements with their investors to obtain signed agreement to any changes to their terms and conditions. 3.3 Money ceasing to be client money Rule(s): 7.2.15R and 7.11.34R to 7.11.40R Date effective: 1 July 2014 and 1 June 2015 The new rules introduce certain clarifications and revisions to accommodate transfer of business, unclaimed client money and a firm s legal obligations to pay client money to a third party. There was a potential conflict highlighted within this section between the HMRC ISA Transfer rules and the proposed CASS rules. Firms required to ensure that transfer details are outlined within their T&Cs. TAs will require sight of firm s T&Cs to ensure that the correct investor service is met. CASS Page 10

3.4 Transfer of business handling client money Rule(s): 7.2.17AG to 7.2.17GR and 7.11.41G to 7.11.47R Date effective: 1 December 2014 and 1 June 2015 The new rules set out requirements relating to assignment clauses in client agreements if they are to serve as client consent to transfer a client s client money to a third party in the context of a business transfer to allow assignment clauses to be used as an alternative to obtaining client consent at the time of the transfer. It is the view of the TA Forum CASS Working Party that firms must carry out appropriate due diligence and ensure that all investor consent has been received ahead of the transfer or via an amendment to a firm s terms and conditions, unless firms have existing contractual arrangements with their investors to obtain signed agreement to any changes to their terms and conditions. TAs will require details of the firm s approach and will most likely deal with such requests as a project. 3.5 Client bank accounts due diligence and diversification Rule(s): 7.13.8R to 7.13.12R and 7.13.20R to 7.13.25R The new rules enhanced the due diligence requirements that firms must carry out on banks with whom they place client money, and require firms to periodically assess whether they are appropriately diversifying the third parties with which they place client money and following each assessment make adjustments (to the third parties and/or amounts placed at each) accordingly. It is the view of the TA Forum CASS Working Party that firms need to take responsibility for determining their policy on the diversification of client money. On receipt of a request from a firm to diversify client money, the TA must deal with this as a project request, taking into account current restraints with the use of the Net Negative Add Back method for client money reconciliations. 3.6 Immediate segregation Rule(s): 7.13.6R to 7.13.7G CASS Page 11

Except where firms are using the alternative approach to client money segregation, the new rules generally require firms to receive all client money directly into a client bank account defined as the normal approach to client money segregation which is the approach adopted by firms, who are not using the DvP Exemption for Collective Investment Schemes (7.11.21 R). However, the final rules have permitted firms who act as a clearing member of CCPs, in certain situations, to receive client money into a house account before transferring it to a client bank account, so long as they maintain prudent segregation in their client bank account to address intra-day risk. Where appropriate to a firm s business, it is the view of the TA Forum CASS Working Party that the rules on client money segregation will also be met by implementing the standard DvP Exemption, for Collective Investment Schemes (7.11.21 R). This will ensure that all money received into a firm s account will be transferred promptly, and no later than 1 business day after receipt, into a client bank account, when received prior to contractual settlement date. 3.7 Physical receipts and allocation of money Rule(s): 7.13.32R to 7.13.33R The rules clarify how firms should treat client money receipts in the form of cash and cheques and how these should be reflected in the internal client money reconciliation. It is the TA Forum CASS Working Party s view that all current dated cheques received by a firm must be banked same day/following working day or rejected. Current date cheques that are retained must be stored securely and included within the internal requirement. Any post-dated cheques to be stored securely, recorded within the firm s records and accounts, but not included within the internal requirement of the client money reconciliation, until they are deposited when they become current, at which point they will be banked and included within the internal requirement. 3.8 Cleared funds Rule(s): 7.12.3G The rules reiterate the principle that one client s money should not be used to fund another client s investment business. CASS Page 12

The best practice view of the TA Forum CASS Working Party is to use organisational arrangements where possible to minimise the risk of using one investor s client money to pay another on an intraday basis. It should be noted that when administering client money, it is not possible to fully control intraday cash flows/movements; as such cash flows/movements are solely at the discretion of the clearing banks within the UK clearing system. Intra-day funding risks will need to be identified and quantified with suitable organisational arrangements to minimise the risks. If such arrangements are not considered appropriate, intra-day funding will need to be considered. Any confirmed shortfalls will require to be funded by close of business on the day of the shortfall. Any systemic or regular failure causing shortfalls will also need to be addressed on an intraday basis and firms will need to consider other arrangements such as prudent segregation in response. It is recognised by the TA Forum CASS Working Party that these arrangements would only minimise the risks and not prevent them and that a firm s arrangements would form the basis of any future FCA supervisory visit. 3.9 Allocation of client money receipts Rule(s): 7.13.36R to 7.13.38G Firms should allocate all client money to individual clients as soon as possible and ensure that any unallocated money is returned within 10 business days. In the event that it is unclear whether money received is client or corporate money this should always be protected in the client money account, whilst the matter is being investigated. If the investigation proves unsuccessful firms should send an instruction to the bank to return the funds to source, within 10 business days of receipt. 3.10 Client money record keeping and reconciliations Rule(s): 7.15 and 7.16 The rules establish clear requirements as to the steps a firm is expected to follow when undertaking an internal client money reconciliation for (a) standard method ; (b) clarifying the circumstances in which a firm is able to undertake a non-standard method of internal client money reconciliation; (c) mandating the minimum frequency at which CASS Page 13

firms should undertake client money reconciliations (both internal and external); and (d) introducing more detailed notification and recordkeeping requirements. Firms must confirm to the TA that they endorse the method of internal reconciliation being undertaken, complete an annual review of frequency of external reconciliations, and complete a general overview of procedures and documentation relevant to this process. Firms must ensure record keeping and notifications requirements are met, ensure procedures and documentation are maintained and reviewed, ensure the firm has endorsed the method of internal reconciliation, ensure discrepancies are dealt with in line with appropriate rules and the firm s SLA, ensure that the new 48 hour notification from the FCA can be met, ensure daily client money reconciliations and calculations are controlled, reviewed and validated. Where a discrepancy in the internal reconciliation is identified as a result of a breach of segregation requirements - must not only address excess / shortfall but also take sufficient steps to avoid a recurrence. 3.11 Internal Client Money Requirement Members of the TA Forum CASS Working Party predominately use the net negative addback method to perform their internal client money reconciliations. In respect of the client money requirement, the FCA has increased the prescription of the components that must be used to calculate this position. CASS 7.16.17 R (1) states the starting point must be the amount which the firm s internal records show as held in that account. The view of the TA Forum CASS Working Party is that this figure could be represented by the cashbook. An offset of any negative amount that can be attributed to an individual client should then be taken into account as per 7.16.17 R (2) to complete the requirement calculation. The aim of the internal client money reconciliation is to compare the resource against the requirement. In the process described above, the requirement is calculated by starting with the resource figure, before adjusting for any negative amounts.. The TA Forum CASS Working Party recognises that this is not a true reconciliation and does not identify the individual clients to which the money belongs. To ensure that the individual client balances can be recognised as part of this process, as required in 7.16.18G (1), a reconciliation of these balances has been introduced which details all clients who hold client money within the bank account as per separate books and records, and these positions are reconciled back to the requirement figure from the internal client money calculation. CASS Page 14

Members of the TA Forum CASS Working Party also use the individual client balances to form the requirement position. While this is closer to the Individual Client Balance method, it does provide a true reconciliation to the resource position, and therefore the Internal Control Check would not be required. This involves using all the records that contain client balances, either through ledgers or reports, to form the balance of the requirement. This would then be reconciled against the resource which would be populated independently. Any genuine record keeping errors can then be driven out and corrected. 4. CASS 8 Mandate rules 4.1 Non-written mandates Rule(s): 8.2.2G to 8.2.6G and 8.3.2R to 8.3.2HG Rules have been revised to ensure firms keep appropriate records of non-written mandates; remove the requirement on firms to hold records of ceased mandates indefinitely; and clarify the form and content of records to be retained around mandates. The view of the TA Forum CASS Working Party is that the same controls need to be in place for non-written mandates as written mandates. It is viewed that electronic mandates are already covered by the existing CASS rules and that the new rules now also cover telephone mandates. The TA Forum CASS Working Party is of the view that a mandate is where a client provides an authority to allow a firm to collect varying amounts from their bank or building society account providing advance notice is given. 5. CASS 9 Information to clients 5.1 Information to clients on safeguarding client assets Rule(s): 9.1.1R and 9.5.1G to 9.5.9G CASS Page 15

Firms are required on request to provide information to investors on their holdings of client assets. They are also required to provide a statement on an annual basis. The firm must ensure that it is clear from the statement when assets and/ or monies are, or are not, protected under either or both the custody rules and the client money rules. The TA Forum CASS Working Party s view is that all items on the client money reconciliation (where a client can be identified) must be reported on the ad hoc or annual statement. For the annual statement, a single date will be used to generate the client money information. A balance, not transaction, history will be provided. If transitory client money items are included on the statements, the nature of them must be clearly explained. Where a relationship can be positively identified between the investor and their advisor a copy of the statement can be provided to the advisor, subject to data protection requirements. References to Client Statements relate to Client Money reporting. It is assumed that unit holding statements will already be in place. 6. Important Information This document has been compiled for the use of TA Forum members only and is for guidance purposes. The best practice statements have been written from the view point of TA s and the administration activities that they perform for regulated firms. Where any firms require further clarification of the rules, guidance should be sought from the FCA. It is the regulated firm s responsibility to comply with the client money rules and ensure that they receive all required information in order that they can perform adequate oversight regularly. Firms are responsible for ensuring they have the relevant permissions to undertake such activity as they may outsource to TA Forum members. It is assumed that firms will have all relevant CASS permissions. The regulated firm and all delegated parties responsible for CASS must ensure that full documented policies and procedures which would not be limited to but could include, contingency processes, frequency of reconciliation, treatment of shortfalls, and unclaimed safe custody assets are in place and are regularly tested and reviewed. It is also the responsibility of the regulated firm to ensure that CASS governance structures are in place. This document must not be copied or distributed without written consent from the TA Forum. For any queries regarding this document, please contact enquiries@thetaforum.co.uk CASS Page 16