On 23 March 2012, the Central Bank of Ireland (the “Central Bank”) published the “Review of the Regulatory Regime for the Safeguarding of Client Assets” (the “Review”). The Review is the result of the findings of the Client Asset Task Force (the “Task Force”) commissioned by the Central Bank in August 2011. The Central Bank sought a review of the current regime in place for the safeguarding of client assets by the Task Force due to a number of factors, including:
- the introduction of PRISM by the Central Bank;
- cases both in Ireland and abroad where issues surrounding client assets have arisen;
- possible changes to European relevant directives; and
- feedback from industry that the current rules for the safeguarding of client assets required review.
The Task Force based its findings and recommendations on the following objectives considered necessary to build the foundations of any client asset protection regime:
- the maintenance of public confidence in the client assets regime;
- the mitigation of the risk of misuse of client assets, whether as a result of maladministration or fraud; and
- the provision of a system, which in the event of a firm’s insolvency, will enable the expeditious return of client assets to the owner at the lowest cost possible.
The Task Force’s recommendations fall under three separate headings, each of which are dealt with below.
The Legislative Framework
The Task Force has recommended that legislative reforms are effected to allow the Central Bank to apply to court for the appointment of an Administrator, or a person with equivalent powers, to take charge of an authorised firm’s affairs. This power should be available to the Central Bank when there are reasonable grounds to suspect that:
- there are serious problems of a financial nature; and/or
- the interests of the investors or clients of the authorised firm are at risk.
The Task Force also recommends the urgent review of the current insolvency regime in line with the “pre-determined distribution rules” drafted by the Investor Compensation Company Limited. However, the Task Force also notes that cognisance should be given to the “Special Administration Regime” for investment firms currently in place in the United Kingdom. The Special Administration Regime provides:
- for an administrator to seek to fulfil certain defined Special Administration Objectives, assisted by the power to set bar dates for claims and where there is a shortfall in client assets the power to distribute the remaining assets on a pro rata basis; and
- for the Financial Services Authority to give directions on which of the objectives should be given priority.
Client Asset Requirements (“CAR”)
The Task Force has suggested the CAR be revised:
- to make greater use of higher level principles duly reinforced with appropriate guidance so as to introduce greater flexibility and an explanation of the rationale behind the underlying rules; and
- to set out the rules in a manner that will help to avoid unnecessary and potentially contradictory statements and in turn will increase the levels of compliance.
In revising the CAR a clear and consistent definition of client assets is recommended to incorporate the presumption that all client funds received or held by an authorised firm will be subject to the CAR irrespective of the intended investment.
While acknowledging the fact that investments in collective investment schemes are subject to specific regulations and are therefore outside the ambit of the CAR, the Task Force recommends that requirements be implemented to protect monies held in subscription and redemption accounts held by financial service providers. While monies held in these accounts may normally only be held for less than a day, or in some cases for up to five days, they constitute client assets. Despite this the Task Force believes the current position to be unsatisfactory and in need of remedy.
The Task Force also looked at the current substance of the CAR. The Task Force has recommended that the daily calculation of a firm’s client money resources remain in place. This daily calculation is deemed necessary in order to maintain a buffer to cover any deficiencies on the different accounts which may arise as a consequence of the manner in which the account was operated. However, the Task Force has also recommended that the formula used to calculate this buffer be revised so as to take account of the business model of the particular firm in question.
The Task Force also identified some additional aspects of the CAR that require attention. In respect of the frequency of reconciliations, the Task Force noted that the daily reconciliations were being carried out where there was no significant risk or information and that the resources to carry out these calculations could be deployed elsewhere. In addition, the Task Force found that there was confusion over reconciliation items and breaches and that the requirement to retain a hard copy of each reconciliation was particularly onerous given the ability to record them electronically. The Task Force found that the requirement to ensure that client assets are effectively segregated from a firm’s assets has led to the placing of assets in third party hands.
Difficulties have arisen when seeking confirmations from these third parties as to the designation of the client accounts, one reason for this is due to the differing terminology made use of in different jurisdictions. The Task Force contends that commonly accepted terminology is preferable and should be considered.
Finally, in a bid to aid the development of a revised CAR, the Task Force has recommended that a working group of the Central Bank and members of industry be established so that detailed proposals can be developed.
As part of the Review the Task Force examined the current procedure in place for the authorisation of holding client assets. Following its review, the Task Force recommends the following:
- that applications to hold client assets should be considered using risk-based techniques so that the applicant’s activities, governance and processes can be properly assessed;
- that authorisations should require sign-off from specialists in the Central Bank;
- that authorisations should lead to a consideration of additional requirements relating to corporate governance and internal controls. This should include the requirement to have an internal audit function, segregated compliance and risk functions and two independent non-executive directors;
- that where an authorisation is granted, unregulated business should not exceed 10% of turnover;
- that the register of firms should disclose whether a firm has secured authorisation to hold client assets; and
- that a copy of the memorandum of recommendation and the letter of authorisation of a newly authorised firm be forwarded to the Consumer Protection Codes Directorate.
With the recent introduction of the Fitness and Probity Regime by the Central Bank the Task Force recommends that a Client Assets Pre-Approval Controlled Function (“PCF”) be introduced for all firms. The individual appointed to the PCF would be responsible for the oversight of client assets within the firm and, in conjunction with the firm’s board of directors, would be responsible for sign-off on the firm’s Client Assets Management Plan (“CAMP”).
Each firm engaged in the holding of client assets is recommended to prepare a CAMP. A CAMP should aid the Client Assets PCF in his/her role and will also aid a proposed new Client Assets Specialist Team (“CAST”) of the Central Bank to engage in risk-based monitoring of individual firms.
The Task Force recommends the establishment of CAST to facilitate cross-sectoral ownership for client asset risk. The CAST will be able to communicate directly with primary supervisors and it is proposed that it adopt a risk-based approach in its investigations. It is also recommended that CAST work with the Enforcement Unit of the Central Bank on a regular basis in order to improve the flow of referrals to the Enforcement Unit.
A Client Assets Review Committee is also recommended to which serious client assets issues can be referred to. The Task Committee also recommends a revision to the approach taken to external auditor’s reports.