In its Consultation paper CP 16/19 the FCA indicated that its implementation of MiFID II will require changes to the FCA’s Client Assets Sourcebook (CASS). The detail of the MiFID II requirements are set out in the MiFID II Delegated Directive on safekeeping, product governance and inducements.
The FCA’s view is that proposals do not mean significant changes to the existing CASS regime because MiFID II is broadly aligned to the CASS and the FCA has already implemented most of the MiFID II requirements.
Nevertheless, the MiFID II CASS amendments will require some work and all firms, even those to which MiFID does not apply, including AIFMs, UCITS managers and depositaries, will need to take steps. We have set out the 10 things which firms need to consider.
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1. Application to all firms, not just those carrying on MiFID business
In seeking to avoid two CASS rulebooks, the FCA has indicated that it will apply the MiFID II requirements to all firms carrying on designated investment business, including non-MiFID business.
Action: All firms, including UCITS managers, AIFMs and depositaries that do not carry on MiFID activities, will need to take note of the changes and implement them as necessary.
2. Prohibition on Title Transfer Collateral Arrangements (TTCAs) with retail clients
MiFID II prohibits firms from entering into TTCAs with retail clients. A TTCA means that the client takes credit risk against the firm. The prohibition will apply both to TTCAs related to assets and to money. The FCA proposes amending CASS to reflect these requirements.
Action: firms will need to revisit their terms of business and ensure that retail clients are able to provide non-cash security or the nature of any such security is changed whereby the retail client retains control over the cash, e.g. a charge over bank account.
3. Appropriateness of Title Transfer Collateral Arrangements (TTCAs) for other clients
MiFID II requires firms to consider whether TTCA are appropriate for the non-retail clients to whom the firm may offer TTCAs. Firms will need to consider the following:
- the relationship between the TTCA and the client’s liability;
- ensuring that the quantum of client funds or assets subject to the TTCA does not vastly exceed the client’s liability; and
- preventing automatic, blanket use of TTCAs for all clients, without considering their liabilities.
The FCA proposes amending CASS to reflect these requirements.
Action: to the extent that firms do not already assess client liabilities, e.g. prime brokerage hypothecation agreements which define client indebtedness and the link between this and the taking of client assets, they will need to implement monitoring systems and amend agreements.
4. Narrowing of custody lien exemptions
MiFID II narrows the exemption in CASS 6.3.6 to only permit a lien to only permit a lien to be given where applicable law in a third-country jurisdiction in which the client’s assets are held requires such a lien. It requires the firm to disclose information to the client so that the client is informed of the associated risks. The FCA proposes amending CASS to reflect these requirements.
Action: to the extent that firms do not already have agreements in place which limit liens to compliance with local law, firms will need to amend agreements.
5. Extension of delegation of third party safekeeping duties to delegates
Currently the FCA requires firms delegating safekeeping duties to a third party to ensure that the custody assets:
- are deposited with a third party in a jurisdiction that regulates and supervises their safekeeping; and
- are not held with a third party in a non-EEA country, unless required by the professional client or nature of the custody assets.
MiFID II extends this requirement where a firm has delegated custody to a sub-custodian.
Action: firms will need to ensure that agreements with custodians reflect these requirements and consider putting in place a system for monitoring this, possibly with a duty of attestation on the custodian that its delegation complies with the requirements above.
6. Reliance solely on credit ratings for a qualifying money market fund (QMMF) no longer sufficient
Currently, a firm may rely on ratings of the QMMF provided by credit ratings agencies as part of its due diligence for investment in a QMMF. MiFID II requires firms to make internal assessments when considering investments of client money in a QMMF with reference to credit rating agency ratings but not reliance.
Action: firms will need to change or put in place a system for making internal assessment of the credit quality of the QMMF using but not relying on the QMMF’s credit rating.
7. Requirement for express consent from clients when depositing money in qualifying money market fund (QMMF)
Currently, there is no requirement for explicit consent from clients for investing in a QMMF. MiFID II requires this and the FCA proposes amending CASS to reflect these requirements.
Action: firms will require minor client agreement updates to reflect this consent requirement.
8. Depositing client money in a group bank
Currently, CASS prohibits a firm from depositing more than 20% of their client money in a bank in the same group as the firm. MiFID II contains the same prohibition, but allows firms an exemption if they can demonstrate disproportionality under the following:
- the nature, scale and complexity of its business;
- the safety offered by third parties; and
- the same balance of client money held.
The FCA takes the view that only a CASS small firm would be holding a sufficiently ‘small balance of client money’ to justify use of that exemption and propose to amend the CASS 7 rules on intra-group deposits accordingly, including the imposition of monitoring and notification requirements.
Action: small CASS firms should consider whether the change benefits them and put in place systems for refreshing the proportionality assessment and making notifications to the FCA.
9. Preventing unauthorised use of client assets
MiFID II requires firms to have in place measures to prevent unauthorised use of client assets including agreed procedures if a client has insufficient assets to settle a transaction, monitoring its ability to deliver securities with remedies in place if this cannot be done, and promptly requesting undelivered securities. Implementing this proposal may involve updating client agreements.
Action: firms may need to change agreements and review/put in place systems and controls for monitoring and addressing shortfalls in client assets and client money.
10. Monitoring the sufficiency of collateral when arranging securities lending
The FCA proposes implementing the MiFID II requirement for firms to take collateral and monitor its continuing appropriateness when arranging securities lending for clients and parties to securities financing transactions.
Action: firms may need to change agreements and review/put in place systems and controls for monitoring and addressing the holding of excess client assets and client money.