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CP13/5 CASS: Review of the client assets regime for investment business

    • Financial institutions



    In CP13/5 the FCA proposes changes to the rules in the client assets sourcebook (CASS) applicable to firms that hold client money, custody assets, collateral and/or mandates in relation to investment business.


    The FCA's Business Plan 2013/14  highlighted that increasing firms’ compliance and awareness of the CASS rules is a key aim in 2013/14.  The FCA intends to increase the supervision of firms holding client money and assets through more intrusive visits to firms, thematic projects and desk-based reviews, actions initiated through Client Money and Asset Return/audit information and taking regulatory action where failings are identified. The FCA has been reviewing the CASS Handbook to re-evaluate issues that have arisen over recent years (for example  use of the deposit exemption and term deposits by FCA authorised firms).  This briefing focuses on the changes which the FCA proposes to deal with those issues.

    Changes to Client Money Rules

    The FCA is consulting on changes to the client money rules, which will affect all firms who hold client money.

    Changes to banking exemption

    The banking exemption allows banks to hold money which would otherwise be client money as a deposit. Banks who are making use of the banking exemption must make various disclosures to clients.  The FCA’s recent supervisory activity suggests that a number of firms do not comply with these requirements or are uncertain as to how they should comply with them. The FCA is proposing that for banks the default position should be that money relating to investment business is held by them under the banking exemption and the bank must notify the client that the money will be held as banker and not as trustee and that the client money distribution rules will not apply. If the bank chooses not to apply the banking exemption and to hold the money as client money then the client should be notified of this and the bank must comply with the client money rules in respect of that money.

    Trustee firms

    A firm that is acting as a trustee firm when it conducts designated investment business, which is not MiFID business, is required to apply only some of the client money rules. 

    The FCA is proposing to amend the rules to make it clear that the client money distribution rules do not apply to client money held by a trustee firm so that on a failure of the trustee firm the money is dealt with by the appointed insolvency practitioner in accordance with the terms of the trust deed under which it is held or in accordance with general trust law.

    The FCA is also proposing  that trustee firms should be permitted to apply the relevant CASS provisions separately to each trust of which they are trustee to enable firms to effectively segregate client money held for different trusts operated by the firm.

    Delivery versus payment exclusion – transactions through a commercial settlement system

    Both the custody rules and client money rules currently allow firms to disapply the rules during the course of a “delivery versus payment” transaction through a "commercial settlement system" if certain conditions are met. The FCA is proposing to amend the rules to clarify the meaning of ‘commercial settlement system’ and to set out exactly when the DvP window begins and ends to ensure that firms are aware that they must be able to comply with the CASS rules should a transaction fail to settle within the DvP window. The FCA is also proposing that clients should have to agree, for example in their terms of business, that their client money or custody assets may cease to be protected through the firm’s use of the DvP window in this way.

    Delivery versus payment exclusion – regulated collective investment schemes and authorised fund managers

    The DvP window which applies to settling a transaction in relation to units in a regulated collective investment scheme  allows an authorised fund manager to not treat money as client money if it receives the money from a client in relation to the authorised fund manager’s obligation to issue units in an authorised unit trust or to arrange for the issue of shares in an oeic subject to certain conditions. This DvP window is also available for redemption proceeds, again, subject to certain conditions.  The FCA is consulting on removing the DvP window so that authorised fund managers should treat money from clients in relation to transactions in units in regulated collective investment schemes as client money and all redemption proceeds in the same way. This should ensure that clients remain protected when their money is held by authorised fund managers.

    Money ceasing to be client money

    The FCA is proposing to clarify CASS 7.2.15R which sets out circumstances under which money ceases to be client money in relation to, among other changes:

    • money ceasing to be client money when the firm transfers money to a third party when it is legally obligated to do so (e.g. to HMRC)
    • allowing a firm to transfer client money when the client has provided consent to a transfer in advance (e.g. through an assignment clause in terms of business)
    • requiring clients to instruct or consent to any payment of client money into a bank account in the name of the client.

    Transfer of business

    Currently if a firm wishes to transfer client money to a third party in the course of a transfer of business the client must obtain either consent to the transfer from each client for whom client money is held or a waiver from the FCA. Although firms may obtain this consent through an assignment clause in their client terms of business, there are no rules or guidance about what is required and such clauses are not frequently used in practice. There is often a timing issue with obtaining consent to the transfer of client money and the process rarely results in all clients responding to a request for consent. The FCA is now proposing to set out a list of matters which if contained in an assignment clause, will provide the client’s advance consent to the transfer of client money along with a transfer of the firm’s business. This may remove a significant hurdle for the transfer of businesses, while retaining protection for clients. Firms will however still need to ensure that the client money will be protected on receipt by the transferee firm and comply with the requirements set out in the assignment clause.

    Allocated but unclaimed client money

    CASS 7.2.19 R allows a firm in the normal course of its business, to cease to treat as client money any balances allocated to an individual client when those balances are unclaimed and the firm is not able to return the money to the client. However the current rule does not expressly state what should happen to the money once it ceases to be client money. This has resulted in some firms writing such amounts back to their balance sheet. The FCA suggests that this is in conflict with general principles of trust law, which state that a trustee should not benefit financially from his position as trustee.  The FCA is proposing to clarify the steps it expect a firm to take before paying money away (including obtaining current contact details for the client and providing details about the method, medium, frequency and intervals of communication a firm is expected to complete) and is proposing to stipulate that these unclaimed balances can only be paid to registered charities.

    Segregation of client money

    Segregation of client money is one of the key safeguards for the protection of client money on the failure of a firm. The FCA is proposing various enhancements to the requirements for segregation

    Client bank accounts

    The FCA is proposing to reinforce the requirements for all firms to hold client money in an appropriate manner with suitable institutions by proposing: 

    • rules requiring firms to consider to a greater extent appropriate diversification of their client money held in client bank accounts to mitigate the loss of client money on the failure of an institution holding the client money.
    • that firms should conduct enhanced due diligence over the banks with which they deposit client money
    • reiterating that the counterparty to the bank must be the firm in relation to client bank accounts. Any bank account in which a firm deposits client money must be in the name of the firm.

    Unbreakable client money term deposits

    The FCA is proposing to amend the rules to make it clear that firms are prohibited from placing client money in unbreakable term deposits or notice accounts by requiring the ability to make withdrawals of client money promptly, and in any event within one business day of a request for withdrawal.

    Immediate segregation

    The FCA is proposing to amend the rules so that all client money must be received directly into a client bank account. This would mean that no client money should be received into the firm’s own accounts but would not prevent a firm from making payments from the firm’s own accounts into its client bank account when such sums are due and payable by the firm to the client.

    Physical receipts and allocation of client money

    The FCA is proposing that firms who receive physical payments of client money such as cash, cheques and payment orders must record their receipt immediately and deposit the client money in a client bank account promptly but no later than one business day following receipt.

    The FCA is also proposing to require that a firm may only apply money on behalf of a client after that money has cleared into a client bank account. That would affect payments, for example, made by cheque, which may take a number of days to clear into the client bank account, and credit cards, which again can take some days to clear into the client bank account. The firm may use its own money to fund a client’s transaction, but  may not use other clients’ money to do this. 

    The FCA also proposes rules around ‘unidentified’ receipts, which the firm believes may include a payment of client money but the firm has not been able to identify to what the payment relates. If the firm reasonably believes that the payment represents client money (wherever received) the firm should segregate the amount that it reasonably believes to represent client money as client money while working to allocate the payment. If the payment proves not to be client money the firm should remove the payment from the client bank account at the next available opportunity.

    Alternative approach

    Under the alternative approach to client money segregation, client money may be received into and paid out of a firm’s own bank accounts rather than client bank accounts. This is relevant for a firm that operates in a multi-product and multicurrency environment for whom adopting the normal approach (i.e. receiving client money into and paying client money out of a client bank account) leads to greater risks to client money than the alternative approach. The FCA intends to restrict the use of the alternative approach to only those firms where its use would be appropriate and expects that the alternative approach should only be used by the largest investment banks and would not expect to see it used in any other types of firm.

    If these changes are implemented, firms will have six months to assess whether the alternative approach remains appropriate for or to change from using the alternative approach to the normal approach.

    Client money held by third parties

    The FCA is proposing to clarify that if a third party ends up holding money for a person who is a client of the firm (rather than a client of the third party), the money remains client money of the firm and it should include these amounts in its internal client money reconciliations.  

    Client money relating to custody assets held at custodians or sub-custodians

    Investment firms who hold safe custody assets may deposit these assets with third parties such as custodians or sub-custodians in accordance with CASS 6.3. When there is activity relating to those assets client money may arise. The FCA is proposing that firms who hold safe custody assets, which deposit these assets with third parties must recognise any money derived from these assets , such as a payment of a dividend or the proceeds of a sale or of stock lending activity, as client money (where appropriate) which should therefore be held in a client bank account in the name of the firm.

    Acknowledgement letters

    CASS 7.8 requires a firm, when arranging to place client money with a bank or other third party (e.g. in a client bank account or a client transaction account), to engage in an exchange of letters providing and confirming notice to the third party of specific matters in order to ensure that the segregation of client money placed with third parties is appropriately secure. To reduce the likelihood of firms making errors with these letters and minimise the risks that flawed letters create, the FCA is proposing that firms be required to use standard template acknowledgment letters. The FCA proposes to require firms to obtain an acknowledgement letter for all client bank accounts (not just those located in the UK) and to remove the 20 business days grace period for firms to obtain a duly countersigned acknowledgment letter (in effect prohibiting the placement of client money into an account until the relevant acknowledgement letter has been signed and returned to the firm).

    The FCA is proposing that all firms be required to repaper their existing notification and acknowledgment letters with the proposed acknowledgment letters. Given the time and costs which could be involved in this type of exercise, the FCA is proposing a six month transitional period to allow firms sufficient time to reissue and obtain updated acknowledgment letters for their existing accounts and is proposing that firms be given the choice to comply with either the current rules or the proposed rules in respect of this proposal during the six month transitional period.

    Extension of Client Money Rules to cover MiFID business and all designated investment business

    The FCA also proposes to change the client money rules so that these rules apply to MiFID business and all designated investment business that is not MiFID business.

    Custody rules

    The FCA is proposing changes to the custody rules in CASS 6, which will affect all firms that hold custody assets. These changes are designed to clarify and enhance the regime to ensure the best protection of custody assets held in relation to investment business.

    Applying the custody rules: physical share certificates

    The FCA has reiterated that it believes that firms who are safekeeping physical share certificates do fall within the scope of the ‘safeguarding’ part of the activity of safeguarding and administering investments.  If they are also administering the assets they would be conducting that regulated activity and would require appropriate permissions and be required to comply with the custody rules as appropriate.

    Delivery versus payment exclusion – transactions through a commercial settlement system

    The same rule changes are proposed on DVP described above as proposed for custody assets.

    Unclaimed custody assets

    Currently there are provisions in the client money rules for firms to deal with unclaimed client money, but there are no similar provisions in CASS 6 to deal with unclaimed custody assets. The FCA is proposing to set out the steps a firm should undertake when liquidating safe custody assets should they wish to do so in circumstances when they are unable to return the assets to the relevant client.

    Registration of custody assets

    A firm may currently register or record legal title to its own assets in the same name as that in which legal title to a client’s safe custody asset is registered or recorded, under a number of specific conditions.  The FCA proposes to remove the ability of firms to register their own assets in the same name as safe custody assets they hold, save where the safe custody assets are registered in the name of the firm itself. Registering safe custody assets in the name of the firm will continue to be permitted only in specified circumstances, namely where the asset is subject to local law or market practice outside the UK and with the client’s agreement.

    Written custody agreements

    The FCA proposes to introduce an explicit requirement for firms to have in place a written agreement whenever they place custody assets with a third party and to provide further clarification on the terms and details that a firm might include in such an agreement.

    Custody assets reconciliations

     The FCA is  proposing to amend and clarify the existing custody reconciliation requirements, setting out that firms should undertake the following types of reconciliations:

    • reconciliation of internal records (‘internal custody reconciliation’)
    • reconciliation of any physical custody assets that are held (‘physical custody reconciliation’) and
    • reconciliation of firms records against third party records where custody assets are held (‘external custody reconciliation’).

    Internal custody reconciliation

    The FCA is proposing to require all firms to carry out internal custody reconciliations in the form of ‘internal custody records checks’. An internal custody record check is a check as to whether the firm’s internal records and accounts of the safe custody assets held by the firm correspond with the firm’s obligations to its clients to hold those safe custody assets using one of the following two methods, namely the internal reconciliation method or the internal evaluation method. Before making use of the internal evaluation of custody records method, a firm should document the system design to show and explain the evaluation it will make of its internal records systems having first provided the FCA with an auditor’s report on the adequacy of the design of the proposed method.

    Reconciliation for safe custody assets held in physical custody

    The FCA propose to require firms to conduct a separate reconciliation specifically for safe custody assets a firm holds in its physical custody in addition to carrying out an internal custody reconciliation. In addition, the FCA is  proposing requiring a firm which intends to use the ‘rolling stock method’ to send to the FCA an auditor’s report on the adequacy of the design of the proposed method.

    Frequencies of custody reconciliations

    The FCA proposes to set minimum frequencies for the various types of custody reconciliations: 

    • internal custody reconciliations - no less than every 25 business days
    • external custody reconciliation -  no less than every 25 business days
    • in relation to assets held in CREST – daily external custody reconciliations
    • physical custody reconciliation - at least every six months.  

    Right to use custody assets

    The FCA believes that the blanket inclusion of the ‘right to use arrangements’ in agreements with clients is inappropriate. Retail clients in particular may be unaware of the increased risks to their assets from these arrangements. The FCA is therefore proposing new guidance in the rules to require firms to consider their client’s best interests when agreeing ‘right to use arrangements’ with clients. The FCA will keep firms’ use of ‘right to use arrangements’ under review and will take further action if necessary.

    Notification requirements

    The FCA is clarifying the notification requirements to ensure that the FCA is aware of instances where firms are not conducting reconciliations and/or topping up shortfalls as required. 

    Client reporting and information (CASS 9)

    The FCA’s current client information and reporting requirements in relation to client assets held by investment firms largely derive from MiFID and are found in the conduct of business rules (COBS 6.1.7R and COBS 16.4). The FCA also has disclosure and reporting requirements specific to prime brokerage firms in the client assets rules (CASS 9). The FCA has observed among clients misconceptions around the protections afforded to client assets. The FCA is proposing changes that are intended to reduce the likelihood of discrepancies between a firm’s records and clients’ expectations and to reduce the number of disputes and queries following the failure of a firm. Other possible benefits of enhanced client reporting and information requirements for firms holding client assets which the FCA has identified include ensuring clients do not unwittingly give away protections otherwise available under the custody rules (CASS 6) or client money rules (CASS 7).

    The FCA plans to require firms to report to their clients on their holdings of client assets more frequently if a client so requests and intends to clarify that any charges associated with these requests must reasonably correspond to the firm’s actual costs for providing the relevant report.

    The current requirements only give rise to an obligation to provide clients with information when a firm is holding ‘designated investments’ or ‘client money’. However, the custody rules (CASS 6) also create obligations about custody assets that are not ‘designated investments’. This includes any assets that a firm holds or may hold in the same portfolio as a ‘designated investment’ held for or on behalf of a client (for example, artwork or crates of wine). The FCA proposes to widen the scope of assets, which could give rise to an obligation to give clients information (under COBS 6.1.7R) to match the scope of assets that a firm might hold under the custody rules (CASS 6).

    The FCA also proposes to remove the distinction made between types of clients in COBS 6.1.7R, with the effect that the same information on client assets would be required to be provided to every client of the firm. The EU Commission is considering introducing similar requirements in the recast of MiFID. (Public Consultation – Review of the Markets in Financial Instruments Directive (MiFID), European Commission (8 Dec 2010) (pg. 71)

    Client Assets Disclosure Document

    The FCA proposes to introduce a requirement for all firms subject to either the custody rules (CASS 6) or client money rules (CASS 7) to highlight to their clients in the form of a stand-alone disclosure document a summary of the key provisions within their client agreements which modify rights or protections, which would otherwise be available to the client under the custody rules or client money rules (‘Client Assets Disclosure Document’). The FCA envisions that where a firm obtains a lien or right of set-off over client assets, has a right to use client assets, has in place a title transfer collateral arrangement or makes use of a client money opt-out and/or the banking exemption (all examples of arrangements which require client consent and affect a client’s rights and/or protections under the client assets rules), this Client Assets Disclosure Document would be used to highlight where those arrangements are explained within the firm’s client agreements. The FCA proposes to require the Client Assets Disclosure Document to include a statement of the likely consequences of these arrangements for the treatment of a client’s custody assets and client money. This would include how client assets may be treated on the failure of the investment firm. The Client Assets Disclosure Document is intended to be a tool by which clients are reminded of the arrangements in place for the protection of their client assets. It is also intended to be a single-source record of the contractual arrangements a firm may have in place which could impact a client’s rights to or interests in client assets.

    Mandates (CASS 8)

    The mandate rules (CASS 8) require firms carrying on investment business or insurance mediation business to establish and maintain certain internal controls when they have mandates to reduce the risk of a firm misusing a mandate. As the rules are currently drafted this only applies in relation to mandates received in written form. The FCA is proposing to extend this to all mandates that a firm receives that are not in written form (for example credit card details provided over the telephone).

    Rearranging the CASS rules

    The FCA will aim to re-order the final CASS rules so they are simpler and easier to follow. 

    Client money distribution regime and changes to comply with EMIR RTS

    In addition to the topics analysed above CP13/5 also consults on: 

    • whether, following the Supreme Court judgment in the Lehman Brothers International (Europe) Supreme Court client money case, the FCA should make changes to the client money distribution regime that will enable the insolvency practitioner of an investment firm that has begun insolvency proceedings to distribute client money based on the firm’s records (rather than agreed claims of clients). This will allow the distribution of client money to be undertaken within weeks of insolvency rather than the years and months it currently takes. If this change is implemented it could increase the speed of recovery and affect the amount returned to clients in most cases. Some clients will enjoy increased recoveries, but there may be less or no recovery for others. At the heart of the proposals is the balance between an ‘accurate’ recovery for clients and the speed at which a distribution should be made following a firm’s insolvency. 
    • changes to client money rules and client money distribution rules to comply with the EMIR Regulatory Technical Standards (“RTS”) on indirect client clearing.

    Deadlines for responses

    Responses to CP13/5 (excluding the EMIR RTS proposals) should be submitted by 11 October 2013. The FCA will consider the feedback and aim to publish final rules in the first half of 2014 (except that it aims to publish final rules in September 2013 in relation to the EMIR RTS proposals).

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