The FCA issued its Policy Statement on client assets in June 2014.
The PS sets out an extensive list of changes to the FCA's client assets and client money rules, which will require a significant number of adaptations, involving client repapering and an overhaul of operational procedures. The changes address a very wide variety of issues but with a common theme to the effect the FCA is looking to increase certainty and speed in the distribution of client assets on a firm's failure.
Some changes described as being optional or of minimal burden were effective from 1 July 2014. The more substantive changes will be effective from two key dates: 1 December 2014 and 1 June 2015. Although the implementation dates are staggered and allow for some transitional time, existing as well as new business will need to be brought into line with the amended regime.
Taylor Wessing LLP encourages firms to consider the changes in their entirety, and in good time, as they touch on a wide range of topics and will impact firms differently depending on their business model.
A detailed summary of the requirements in PS 14/9
Title transfer collateral arrangements – Firms will need to have a written agreement in place with clients addressing the terms of any TTCA, the occasions or conditions on which title transfer will be in effect from time to time and the terms on which the transfer will ultimately cease. New clients need to be papered by 1 December 2014, existing clients by 1 June 2015.
The new rules also require firms to respond to requests from clients to terminate a TTCA in a way that is designed to promote certainty in the face of subsequent client assertions. The new rules set out a process for firms to follow by way of recording and responding to such requests and (if they agree) how the point of termination should be stipulated and implemented.
While the purpose of the changes is to minimise the scope for uncertainty as to the status of a title transfer, the focus on termination means firms will need to think through whether and if so how a title transfer termination could be effected and what would mean for the wider client service.
DvP exclusion for commercial settlement systems – The FCA is concerned firms are using the current DvP exemption for assets and client money for too long. The changes sharpen the parameters, adding a new definition of a 'commercial settlement system' and providing that the 3 business day long stop period now runs from the date the firm first uses the exemption. The rules clarify that only firms that are directly using the commercial settlement system can use the exemption; it cannot be used if firms are not members, participants or sponsored, or if the trade is settled on behalf of the firm through another person's account. The revisions alter the point at which client money / client asset protections must be reinstated after settlement (even within the 3 business days' long stop), or where delivery does not happen within the long stop. Firms should check their systems to ensure they are sufficiently agile to address these different timing scenarios. Firms must obtain a client's written agreement to the use of this exemption: new clients need to be papered by 1 December 2014, existing clients by 1 June 2015.
DvP window for CIS - The DvP CIS window has been adjusted such that the reprieve does not link to whether (for issues) a unit price has been determined, or (for redemptions) whether money is paid to the client under the COLL timelines. Instead in both cases the money has to be paid through to the depositary or the client respectively by close of the business day following receipt. The upshot is likely to be that more AFMs will be seen as processing client money. Our experience is that in applying the revised rules AFMs will need to think carefully about the legal relationships that arise as part of their unit sale/redemption process, taking into account any own account dealings. Firms must obtain written client agreement to the use of the DvP CIS window exemption, which will require repapering. Compliance is required from 1 June 2015.
Banking exemption – The FCA has tightened existing measures to clarify when funds can be treated as being held on deposit (applying different definitions depending on whether the bank is a CRD or non-CRD institution) and clarifying that if for example funds are passed to a third party, this might cease to be the case. Banks will, therefore, need to be clear in their minds as to when the exemption applies. The revised rules require fuller disclosure as to the consequences of funds being held by the bank as banker and the circumstances (if any) where funds might be held as client money (with consequential changes to terms of business where required).
Transfers of business and assignment clauses – Revised FCA rules set out a framework that is permissive of firms either: (i) obtaining client consent to a transfer of client money; (ii) using a 'transfer' clause in terms of business pre-approving a transfer without consent in the future (providing certain conditions such as notifications are met); and (iii) transferring de minimis sums without consent subject to notification requirements. Firms will be well advised to consider these options and ensure they are well placed to take advantage of them, including, if appropriate, by making changes to client terms.
Right to use – New guidance specifies that firms should only use assets belonging to retail clients for securities financing transactions and not otherwise. Revised rules also emphasise the need for firms to keep clients' best interests in mind when doing so. Commentary in the PS itself makes it clear that the FCA does not expect firms to obtain consent to a 'right to use' through blanket terms of business, so firms need to develop specific terms for these business lines.
Diversification – The new rules enhance the expectation the FCA has of firms to carry out periodic assessments of whether they have appropriately diversified their holdings of client money, setting out a list of matters to which firms should have regard. Firms need to keep a written record of these diversification reviews, as well keeping records of both their initial and ongoing due diligence around bank selection.
Registration of assets – The FCA has tightened the rules regarding registration and recording of legal title, in a particular setting out a hierarchy as to when registration/recording of legal title in the name of the client, a nominee, a third party or the firm is possible. The current language suggesting some exceptional circumstances could arise ("To the extent practicable…") has also been deleted. The amended rules also narrow the circumstances when a firm can register or record its own assets in the same name as that used for the client. The FCA specifies that this must be due either to an overseas market issue or be incidental to the firm's custody business carried on for the client or be incidental to CASS compliance (new guidance gives examples of where this could happen). Firms should ensure their registration and recording procedures will comply with the new requirements.
Unclaimed client money – Revised rules effective from 1 December 2014 set out a far more specific framework as to how firms can deal with unclaimed client money and assets. The rules apply a revised set of conditions before payments can be made to charity and require firms to provide a binding undertaking to reimburse clients if they subsequently make a claim. For client money only there is an alternate and lighter touch regime for de minimis sums (£25 retail, £100 professional). Firms are reminded that the FCA's rules only address the discharge of a firm's duties under the FCA's rules and not any other legal obligations they may have.
Written custody agreements – Although it may come as a surprise to some that it was not already a strict requirement, the revised rules require a firm, when placing assets into custody, or when arranging custody for a client, to enter into a written agreement with the provider clearly setting out the custody services, even on an intra-group basis. The FCA is not prescriptive of the form of the agreement as such, suggesting that using standard terms of business may be sufficient to achieve compliance. Firms have until 1 June 2015 to bring existing arrangements into line, but new or materially amended services need to comply from 1 December 2014. Added to this, when selecting third party custodians, firms need to be mindful of certain revised record keeping and review obligations in effect from 1 June 2015.
Acknowledgement letters – PS 14/9 embeds the template letter to be used when firms place client money with third parties (in a client bank account or client transaction account) and mandates how these are used practically, addressing issues such as letter head, extremely limited flexibility around wording, countersign grace periods and requirements as to overseas banks, CCPs and signing authorities. Firms need to study the rule changes carefully and ensure their processes and staff training reflect the practical requirements. Firms can use the new templates from now onwards, but must do so for new accounts from 1 December 2014 and must repaper all existing accounts by 1 June 2015.
Interest on client money – The FCA has clarified that firms can contractually agree the amount of interest arising on client money, but it is clear that in the absence of a written notice to a retail client, all interest earned on the client money is payable. Reading across both the new rule and new guidance, it is unclear whether a written notice or terms of agreement is required (particularly for retail clients) and the rules are not specific as to a default position for non-retail clients (i.e. where nothing is said about interest). We suggest firms are clear about the position in their terms of business.
Record keeping, checks and reconciliation – This area is a major focus for the PS as the FCA indicates there are still frequent instances of firms not understanding their record keeping, record checking and reconciliation duties. Firms need to prepare to meet additional obligations and in particular be ready to meet the clarified need for a "client specific safe custody asset record" as well as ensuring their systems meet the FCA's more particular demands regarding internal custody record / evaluation checks, physical asset reconciliations and external custody reconciliations. Firms may need to conduct reconciliation and oversight more frequently and adjust the scope and nature of their record keeping generally.
Discrepancies in client assets – In short, discrepancies need to be corrected whereby a firm must ensure that: (1) it is holding the correct amount of assets; and (2) both its and any third party's records are reconciled. The new rules specify a gradation of duty; moving through different levels of investigatory duty and potentially culminating in a duty to apply own assets to the shortfall and notify clients. In terms of applying own assets, there is allowance for situations where a third party is responsible; we suggest firms will need to establish a protocol to help determine when they can rely on this.
A point for firms that currently hold client funds under the banking exemption, or under title transfer, is that where they need to apply own funds against a shortfall, they will need to hold these funds as client money – so they will need to ensure they have regulatory permission to do so and set up a client money compliant system. They may also need to re-paper clients to ensure their terms are consistent with this position.
CASS 8 mandate rules – The revised rules require firms to have the appropriate systems and controls in place for non-written mandates (for example, paperless direct debits) as well as written mandates. We suggest firms review their operations to identify where non-written mandates arise and make sure they comply with the rules.
CASS 9 information to clients – The revised rules impose new obligations in terms of information provision: firms must respond to client requests and can only charge a sum that reasonably corresponds to actual costs. Requests for repeat statements need to be provided within 5 business days. Firms will also need to indicate in statements whether an asset or sum of money reported is or is not subject to the client money or client asset protection rules. Additionally, the FCA has clarified and extended the range of client types and asset types on which information should be provided. Firms should amend their systems ready to meet these new provisions by 1 June 2015.
How should you approach the changes?
Significant changes are required in a short timeframe. This suggests your business needs to draw together a team quickly to:
- identify how you need to alter your business operations and processes to meet the new rules and guidance;
- reflect on whether you have the right permissions;
- amend your terms of business to reflect practice and the new regulatory requirements; and
- seek client agreement, where necessary.
We suggest your implementation team should comprise senior business staff, operations and IT and systems experts as well as legal and compliance personnel.
For many businesses, we anticipate a particular challenge may involve adjusting and co-ordinating processes, reporting, record keeping and reconciliation across a range of legacy IT systems.
It is advisable for this team to spend time taking on board the specifics of the revised CASS regime as much of its relevance to your firm will involve analysis of the detail in the requirements against the nuances of your firm's processes, and this may involve taking express, comprehensive advice. We have considered some of the key developments under PS14/9 - but given the breadth of the FCA's exercise this is by no means an exhaustive, one-size-fits-all summary.
Further changes ahead?
At this stage, PS 14/9 does not progress the main elements of the proposals on client money distribution rules from CP13/5. The FCA says it has listened to industry commentary on these points but recognises that it should wait for the outcome of the review of the Investment Bank Special Administration Regulations.
It is also worth mentioning that the FCA recognises that the new regime may be seen as gold plating the MiFID regime and needs to be factored into regulatory revisions needed to accommodate the MiFID II measures (published in the OJ on 12 June 2014).
ISA managers and certain deposit takers may also want to keep in mind that the FCA issued PS 14/10 Client money held in Individual Savings Accounts to address how the FCA's client money rules are affected by changes to the ISA regime (effective 1 July 2014). This Policy Statement was released following a short consultation (CP 14/9 released on 11 June 2014).